Wednesday’s announcement by the Federal Reserve was a first step towards reducing its monthly bond purchase pace. This is the Federal Reserve’s first move to reduce the huge amount of assistance it has been giving markets and the economy.
In its post-meeting statement, the Federal Open Market Committee stated that bond purchases will be tapered “later in the month”. The process will see reductions of $15 billion each month — $10 billion in Treasurys and $5 billion in mortgage-backed securities – from the current $120 billion a month that the Fed is buying.
The move was made by the Committee “in consideration of the significant further progress made by the economy towards the Committee’s goals since December last year.”
This unanimously approved statement stressed the Fed’s independence from a predetermined course of action and that it will adjust the process as necessary. ((*()How tapering worksAccording to the Committee, “similar reductions of the pace at which net assets are purchased will be likely each month.” However, it said that it was prepared to adjust purchases as necessary if the economic outlook changes.
Following a series Fed signals that the Fed would start winding down its program in March 2020, this move aligned with market expectations.
Covid pandemicPositive reactions by the markets saw stocks turn positive, and yields for government bonds increasing.
Inflation was also a minor change by the Fed, which acknowledged price rises were more rapid than forecasted but did not abandon its controversial use of the term “transitory.”
According to the statement, “Inflation has risen significantly and is largely due to factors which are likely temporary.” The large price rises in certain sectors have been caused by supply and demand imbalances resulting from the pandemic as well as the opening of the economy.
Many market participants expected the Fed’s withdrawal of transitory language due to the continued inflation gains.
Paul Ashworth of Capital Economics, the chief U.S. economist wrote, “The Fed announced its QE taper this morning, as widely predicted, but still insists that inflation surge is ‘largely,’ transitory,”
He said that he expected inflation to continue rising while supply problems persist and then begin to fall around the middle 2022.Jerome PowellHis baseline assumption is that supply chains will remain in a state of crisis and there will be shortages well into the next year. This could lead to higher inflation. As the pandemic supplies decrease supply chain bottlenecks will subside and growth will rise, inflation will drop from current elevated levels.
In the statement, it was also stated that economic growth is possible after supply chain problems are addressed.
According to the committee, “Progresses in vaccines and an improvement in supply restrictions are expected be supportive continued gains in economic activities and employment as well a fall in inflation.”
FOMC votes not to increase interest rates beyond their anchor at zero. This was also expected by market participants.
Investors should not interpret a decrease in purchases as an indication that rates will rise.
Powell stated that “we don’t believe it’s the right time yet to increase interest rates.” Powell stated that there is “still a lot to be done” before the Fed can achieve its economic goals. He stated that he would like to see “the labor market heal further” and said there are good reasons to believe this will occur as the delta variation declines. This is what it’s already doing.
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However, markets have become more aggressive with pricing and at one time indicated as much as three additional increases for next year. Wall Street has been anticipating a less dovish Fed to try and balance rising inflation with slowing growth, but this sentiment has started to cool down in the recent days.
A clogged supply system, rising consumer demand, and a labor shortage have all contributed to the inflation rate reaching a 30 year high. Although the Fed maintains that inflation will return to their target of 2% eventually, they now admit that this could be a longer process.