Federal Reserve Announces More Aggressive Taper Schedule, Purchases To Be Over By Mid-March, Transitory Retired

FS Insight Team

As most Fed-watchers expected, the persistently high inflation numbers and building hawkish chorus on the committee resulted in the FOMC shifting course and speeding up the pace of the tapering of asset-purchases. Inflation has been persistently above the targeted levels. This coupled with improvements in the labor market appear to have made the FOMC willing to speed the pace of decline in what has been the most accommodative posture in the history of the world’s most important central bank.

The committee changed its inflation outlook to get more in line with what the actual numbers have been and also reduced the projected level of unemployment for YE. The Fed’s narrative has shifted from fighting the pandemic to fighting a more persistent than anticipated inflationary pressure.

As Mr. Powell noted, even though he still believes much of the positive pressure is related to supply chain interruptions and unique factors caused by the pandemic, the danger of inflation expectations causing a dangerous self-fulfilling prophecy is real. The term transitory was officially removed from the FOMC statement in a coup de grace for the faithful and contreversial term.

The action was initially received warmly by markets but this didn’t last. Technology took a bit a hit as much of the safest and largest technology stocks attract capital as bond proxies when rates are this low. The theory is that as rates rise and safer options for yield become more plentiful, that the relative lustre of the tech titans stocks decreases. On the other hand, 75 bps seems in many ways not an adequate match for the most robust commercial entities in human history.

Powell admitted that a lot of the Fed’s forecasts were simply based on assumptions that proved incorrect. This reality in itself shows the difficulty that even all the kings horses, and all the kings men face in the art of forecasting given the unique and unpredictable factors and catalysts that are driving markets in the wake of this pandemic.

The peanut gallery is of course well into the process of reading the tea leaves to see what this prodigious decision means. Some inflation hawks appear let down like the Fed’s action didn’t go far enough. Talking heads have been very critical of the Fed and some have suggested the miscalculation on inflation is the greatest analytical error in the central bank’s 108 year history. However, for what its worth, we believe Jay Powell handled this difficult pivot pretty well, as we’ve commented before, we’ve learned to respect his dance moves as Fed Chair.

The order of operations has been explicitly laid out by the Fed. The acceleration of the taper schedule holds particular importance because of this, it has direct bearing on when the Fed can use its main policy tool of raising rates. Since tapering will be over sooner, the dot plot has also changed and now suggests that there will be three .25 bps rate rises in 2022. However, Powell has maintained flexibility by not defining what his definition of maximum employment is.

The tapering of monthly purchases of $80 bn of Treasuries and $40 bn of MBS began in November, with a reduction of $10 bn and $5 bn, respectively. That has been accelerated to double the pace. The Fed will be done with asset purchases in mid-March 2022 at this pace. The benchmark yield on the 10-year settled down a bit from last week at 1.407%.

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