By Tim Sharp
Following Ben Bernanke’s 2013 market induced taper tantrum Chairman Powell has been keen not to be responsible for a repeat by carefully planning his press releases since the summer so as not to spook the bond market. The results seem to suggest that he has successfully convinced the market that there is a difference between the reduction or tapering of quantitative easing and initiating a rate hiking cycle. Arguably the press release following the September Fed Open Market Committee (FOMC) meeting pointed to a more hawkish Fed outlook than the market probably expected. However, this failed to trigger a major reaction especially as the global stock markets have been in a state of flux following the anxiety surrounding the potential failure of Chinese property developer Evergrande; rising cases of the Delta variant threatening global growth prospects in the second half of 2021; rising inflation that may become persistent rather than transitory; and an FOMC meeting to discuss the reduction in US bond market support.
Last night’s meeting made the balance sheet the focal point with Powell stressing that no inference should be made regarding the path for rate hikes[1] which have a clear higher hurdle. Powell made an unambiguous statement that barring surprisingly bad economic data over the next month, we should assume that the tapering process will be initiated at the November meeting and will reduce its purchasing of Treasury Securities to conclude around the middle of next year. This translates as a reduction of $10bn per month from November until June which arguably is a much more aggressive taper than the market had expected[2].
The market’s reaction was startlingly benign, we believe a testament to the management of the Fed’s press releases. Bond market volatility has remained low, stock markets ended the day mainly flat while the VIX index hovered around 20.
For the record, the benchmark overnight lending rate was kept in its current range of 0% – 0.25% where it has remained since March 2020. The minutes that are released on October 13 should continue to imply that balance sheet actions are separate from a hiking cycle but the “dot plot” of members interest rate forecasts should show that more members now expect to start raising interest rates next year. Nine, up from seven in June, out of eighteen members, now expect the hiking cycle to start next year leaving only one, down from five, that forecast rates to remain unchanged by the end of 2023. This is a clear indication that the FOMC has grown more hawkish than it was at the June meeting. The swifter pace of interest rate hikes from policymakers’ last set of projections in June comes amid the fastest economic recovery in U.S. history after a brief recession last year, and robust debate at the Fed about balancing its maximum employment and 2% average inflation goals[3].
The FOMC projections for PCE inflation see inflation ending the year at 4.2% before falling to 2.2% in 2022 and 2023 getting back to 2.1% in 2024. This underscores the belief that the current high levels will be transitory and shows less confidence in GDP growth being maintained. Real GDP growth is forecast to be 5.9% at year-end (7% in June), falling to 3.8% by the end of next year, and 2.5% in 2023[4]. Looking at US breakevens the Fed would seem to be more confident in its inflation forecast than bond markets who price the 6-year breakeven rate at 2.51% well above the longer run projection of 2%2.
Although the median interest rate of 1.8% by 2024 is still below the 2.5% level seen as neither stimulating or restricting growth over the long run3 the US Treasury yield curve between 5 years and 30 years flattened 1% after the press release suggesting that the risk of a monetary tightening mistake by the Fed has risen. The Jackson Hole symposium suggested that the Fed would be inclined to run inflation “hot” under its new Average Inflation Targeting strategy but a forecast that sees inflation falling back to 2.1% in 2024 after a decade under target will not feel particularly accommodative to some in the long run and may bring into question the reflation trade. However, the markets reactions show no fear of the taper despite a more hawkish press release than many would have expected, and bank shares as well as the wider stock market seems to be continuing its long term rally after a brief stumble on Monday.
[1] Morgan Stanley – FOMC Reaction: A Tidy Taper – Ellen Zentner – September 23, 2021
[2] Bloomberg – Points of Return: The Tapir Cometh – John Authers – September 23, 2021
[3] Hottinger & Co. Limited – FOMC – Quick Summary – Adam Jones – September 22, 2021
[4] FOMC Summary of Economic Projections – September 22, 2021
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