Federal Reserve expected to offer clues on stimulus taper timeline

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Federal Reserve officials are expected to next week send a clearer signal about plans to begin phasing out pandemic-era stimulus as early as November as US consumers continue to power the economic recovery.

The policy-setting Federal Open Market Committee convenes on Tuesday for a two-day meeting that should shed light on the fate of the enormous bond-buying programme it put in place last year to stabilise financial markets and shore up the economy. 

The details will be accompanied by a fresh set of projections for growth, unemployment and inflation and, most importantly, individual expectations for when interest rates may begin to rise from today’s near-zero levels.

Jay Powell, the Fed chair, said last month that he believes a move to reduce or “taper” those purchases by the end of the year could be “appropriate” if the economy continues to evolve as expected. That message was reiterated early in September by one of his closest senior colleagues, John Williams, president of the New York branch of the central bank, even after a surprisingly weak jobs report in August.

The Fed has pledged to buy $120bn of Treasuries and agency mortgage-backed securities each month until it sees “substantial further progress” towards inflation that averages 2 per cent and maximum employment. 

Powell last month indicated the first of these goals had already been met. The pace of US consumer price growth is still hovering near a 13-year high amid signs it is beginning to crest in some sectors and broaden out in others. He also noted “clear progress” in the labour market recovery. 

$120bn a month is just an enormous amount of money, and they announced it in the absolute throes of last year when the world was falling apart. Now, you are on the other side

His more “hawkish” colleagues have argued the economy is already on firm enough footing to begin scaling back support, suggesting an announcement as early as November.

“They said they would give us a lot of advanced notice,” said Diane Swonk, chief economist at Grant Thornton. “We need a warning now, and we need a road map.”

A November move would give the Fed only one more jobs report to assess before making its decision, while waiting until December gives the central bank time to parse both September and October’s job gains. Another “dud” report could postpone the early timeline, said Michael Feroli, chief economist at JPMorgan, although he said it would take “something quite bad to knock them off track now”.

Economists anticipate that such a pivot is coming, with the statement to be released after the meeting’s conclusion on Wednesday updated to reflect the progress so far made towards these two tapering thresholds. Barbara Reinhardt, head of asset allocation at Voya Financial, also expects Powell to be “resolute” that tapering is not tightening and that the timing of a reduction in asset purchases confers no signal about future interest rate increases.

“$120bn a month is just an enormous amount of money, and they announced it in the absolute throes of last year when the world was falling apart,” added Ajay Rajadhyaksha, head of macro research at Barclays. “Now, you are on the other side.” 

Once the Fed begins to taper, which he thinks will kick off officially in December, Rajadhyaksha predicts a pace of $25bn-$30bn per meeting so the process is wrapped up in the second quarter of next year. Others suggest a slower pullback of $15bn.

The meeting will also bring new forecasts about the economic outlook and a hotly anticipated update to the “dot plot” of individual interest rate projections, which for the first time will include a 2024 forecast. The latest release in June indicated at least two interest rate increases in 2023, a faster pace than expected and which jolted financial markets.

The September update could bring yet another surprise, despite Powell cautioning the dot plot should be taken “with a grain of salt”.

Roberto Perli, a former Fed staffer and head of global policy research at Cornerstone Macro, warned of significant “upside risks” this time round that may indicate a more aggressive approach to scaling back monetary support.

“The dots are a big unknown,” he said. “We know they are not commitments, but still the market pays a lot of attention to them.”

Steven Englander at Standard Chartered speculates enough Fed officials could move up their timeline for lift-off so that the dot plot shows an interest rate increase in 2022. That is likely to come alongside a sharp revision higher in the inflation forecast, which in June was at 3 per cent for 2021 and 2.1 per cent for 2022.

The trajectory for gross domestic product growth may slip, Englander added, but any downgrade would reflect supply-side issues rather than a cooling off of demand. The latest retail sales report showed consumers spending at a healthy clip despite renewed virus concerns.

Economists at Morgan Stanley predict no increase priced in for 2022, but more pencilled in for subsequent years. Another is set to be added in 2023, for a total of three, followed by three more throughout 2024

“As we get more in the clear as it relates to Covid and the economy is starting to settle into a nice groove, we are finally going to see what pace the Fed is expecting from a hiking perspective,” said Tom Porcelli, chief US economist at RBC Capital Markets. “We will start to see a pattern emerge.”