- Asset purchases to be reduced starting mid-November
- QE likely to be wound down by mid-2022
- More stringent conditions for rate hikes still not met
While it came as no surprise, today’s tapering announcement is an important step in the Fed’s transition away from the ultra-accommodative policies it put in place in the early stages of the pandemic. Given “substantial further progress” toward its policy objectives, the Fed will reduce monthly Treasury purchases by $10B to $70B and MBS purchases by $5B to $35B beginning later this month. A similar reduction is scheduled for December, and that pattern is expected to continue next year (subject to changes in the economic outlook) ultimately reducing net purchases to zero around mid-2022. The Fed carefully laid the groundwork for today’s move and markets have digested that gradual shift with relative ease. That continued today with a fairly modest increase in longer-term bond yields post-announcement.
With the Fed starting to wind down QE, focus is naturally shifting toward the timing of the first rate hike. The Fed has been keen to emphasize a more stringent set of criteria for liftoff—maximum employment and inflation at 2% and on track to exceed 2%— and reiterated that message today. But it’s fighting a global trend in which inflation concerns have investors questioning central banks’ commitments to hold rates low until economies fully recover. Today’s policy statement pushed back on that view, saying the factors driving inflation higher are “expected to be transitory” and that vaccines and easing supply constraints should support continued job gains and a reduction in inflation.
We think it might not be as simple as that and see some downside risk to the Fed’s September growth forecasts, and upside risk to its unemployment rate and inflation forecasts for next year. That could prove to be a more challenging combination for the Fed, and Chair Powell fielded several questions today on how the committee would handle conflicting inflation and employment objectives. He said it would take a risk management approach but acknowledged that the risk “appears to be skewed toward higher inflation” and that “we need to be in a position to act if in case it becomes appropriate to do so.” We think that will be an evolving discussion in the coming months but for now we remain comfortable with our forecast for interest rate liftoff in late-2022, which is slightly later than markets are pricing.