After Monday’s market turmoil, the Federal Reserve’s challenge will be to be reassuring while acknowledging that it is preparing to take its first big step forward from the easy policies it has put in place to tackle the pandemic. .
The Fed will issue a policy statement along with the economic and interest rate forecasts it releases quarterly at the end of its two-day meeting on Wednesday afternoon. Fed Chairman Jerome Powell is expected to brief the media at 2:30 p.m. ET. The central bank is expected to give ample indication that it is preparing to announce that it will start cutting back on its $ 120 billion in monthly treasury bill and mortgage-backed securities purchases.
“I think they’re going to state that they had a discussion about tapering. I don’t think they’re going to provide any details. I think they’re going to provide a framework where they can start doing it in November or December, âsaid Rick Rieder, director of global fixed income investments at BlackRock.
The Fed meeting began on Tuesday, after a turbulent day in global markets, over fears that major Chinese real estate developer Evergrande could collapse and spread contagion beyond Chinese borders. The S&P 500 had its worst day since May, but on Tuesday stocks stabilized a bit as investors looked to the Chinese government to contain the situation.
“Did the price action of the last two days in the markets or in China influence their thinking?” I guess that’s going to get into the discussion, but I still think they’re going to end up in the same place we were going to end up in, âRieder said.
He expects the Fed to cut purchases at a rate of $ 10 billion of treasury bills and $ 5 billion of mortgage-backed securities per month, once it starts to decline.
What could move the markets
âOverall, tapering is probably not a market shift event,â said Anwiti Bahuguna, head of multi-asset strategy at Columbia Threadneedle. She said on Wednesday the focus would be on forecasts and the Fed’s dot plot, the chart it uses to present anonymous interest rate forecasts from central bank officials.
While the Fed’s decision to move away from asset purchases may be well publicized, strategists say its interest rate forecast may be a wildcard for the markets. The Fed’s inflation expectations will be closely linked to this. In June, it forecast 3.4% for the inflation index of personal consumption expenditure this year, before falling back to 2.1% in 2022.
Also in their June forecast, Fed officials targeted the first two increases to the target federal funds rate in 2023, but there is a risk that could change. Two officials expected the first hike in 2022, and many market professionals are betting it will rise by the end of next year.
“If we see just two or three members change their mind, it might be a hawkish surprise. There is no way that [Fed officials] is going to take the points off, so the risk is that there will be more points that appear in 2022 and 2023, and the market starts to think that the rate hike cycle begins next year, âBahuguna said. She said it would be a “hawkish” message that would be negative for stocks, and it could result in higher interest rates at the short end of the Treasury curve.
In June, the addition of points to the 2022 forecast came as a surprise and suggests that some members of the Fed see the increase in inflation as something more than transient, she said. There is a risk that could reoccur if more Fed officials believe inflation is more persistent.
Powell has repeatedly stressed that he believes the surge in inflation was temporary, but some officials within the Fed rejected the idea.
Consumer price index inflation has exceeded 5% over the past three months, although the pace slowed slightly in August.
Rieder doesn’t expect the Fed to change its 2022 interest rate forecast, although it is revealing its 2024 forecast for the first time. Those longer-term forecasts change often, he said.
âI still think they can go down and leave a window, an option for them to move on and start raising rates in 2022,â Rieder said. “I think they’re going to decouple the taper of rates, but that will give them the option of actually being able to go there in 2022, assuming employment continues to improveâ¦ But I don’t think they’re passing that on from anyway. that’s their base case, far from it. “
Push back rate hikes
Rieder said that insisting on ending the bond buying program doesn’t mean a rate hike is coming, the Fed will make the taper more dovish.
But the bond market will still focus on projections for rate hikes and inflation.
“Powell will probably do his best to distinguish and decouple the association of tapering and rate hikes,” said Mark Cabana, head of US short-rate strategy at Bank of America.
âWe believe they are going to make some modest adjustments to their overall economic and inflation forecasts,â Cabana said. “So we think they’re going to dampen growth this year, given the weakness in recent data. They’ll mark inflation given the firming we’re seeing. The real focus will be on the dots. We still expect no hikes. in 2022, but they will add 2024. We expect that will show three more increases in 2024. “
Rieder has been a supporter of the Fed’s decision to relax its ease policies. He said Fed policy and the economy didn’t work the way they used to.
âI think there is something critical here,â he said. “For our generation we are used to the data softening, monetary policy has generally been a driver of modulation … but the softness of the data comes exclusively from the supply side which is not affected by the modulation. Monetary Policy.”
Demand is high, but supply chain issues and shortages have caused the economy to slow down. By stimulating the economy with an accommodative policy, the Fed is adding to this dynamic.
Market pros also expect Powell to be asked about recent reports that Fed officials are holding and trading securities. A close review by CNBC of officials’ financial information revealed that three people last year held assets of the same type that the Fed itself was buying, including Powell who held municipal bonds. Boston Fed Chairman Eric Rosengren invested in REITs and Dallas Fed Chairman Rob Kaplan held corporate bonds. The transactions appear to be in accordance with the Fed’s rules, and the Fed is conducting a review.