Federal Reserve Chairman Jerome Powell testifies during a hearing of the U.S. House Oversight and Reform Selection Subcommittee on the coronavirus crisis on June 22, 2021 on Capitol Hill, Washington.
Graeme Jennings | Swimming pool | Reuters
When the Fed emerges from its July meeting on Wednesday afternoon, it may sound a little more vulnerable to maintaining its ultra-loose policy than expected a few weeks ago.
Federal Reserve officials are likely to raise concerns about the rapidly spreading delta variant of the coronavirus. The market has been waiting to hear from the Fed about its plans to reduce its bond purchases, the first big step in easing policy.
“This should be the meeting where they really focused on tapering,” said Mark Cabana, head of short US rates strategy at Bank of America. “We believe that the Powell market will end up sounding neutral to cautious, at least from an interest rate market perspective, mainly because he will continue to talk about downside risks from Covid.”
The Fed released a statement on Wednesday at 2 p.m. ET following its two-day meeting. Chairman Jerome Powell will speak to the media at 2:30 pm
Fed watchers expect officials to speak of reducing their monthly minimum purchases of government bonds and mortgage-backed securities by $ 120 billion. They also expect settlement to begin later this year or early next year.
Powell is also expected to maintain the view that the recent surge in inflation is temporary and that it will subside after an outbreak of pent-up demand spending and after supply chain issues are resolved.
“In the FOMC statement, they talk about how the path of the economy depends on the path of Covid,” Cabana said. “Because of this, you will of course sound cautious. You will be talking about the tapering, but that will be a formality as you have to be aware of the increasing downside risks.”
The timing of the rejuvenation
The Fed was widely expected to have serious discussions about withdrawing its bond purchases at its Jackson Hole symposium in late August or at its September meeting. Some expected the slowdown in buying to begin before the end of the year.
However, Cabana has been careful to get the Fed to start tightening early next year, slashing mortgage and government bond purchases evenly over a 10-month period.
“I think the Covid resurgence is pushing back the notion that they will start reducing in the fourth quarter,” he said. “I think we can all agree that if we live with Covid longer than we thought inflation may become less of a concern as demand will fade. In this context, we think that there really is one thing … the world, and that is the way this virus goes. “
Cabana said he expected the Fed to signal at its September meeting that it would slow down bond buying. He’s also looking for Powell to say the purchases don’t have to be mechanical, and the Fed could slow them down or speed them up if it wants.
The Fed is widely expected to take up to a year to end buying, by which time it could be ready to hike rates. In its forecast, it provides for two rate hikes in 2023.
“He has to admit that the Delta variant makes the uncertainty about the outlook much greater. He has to be very careful with his words,” said Diane Swonk, chief economist at Grant Thornton. Economists said the delta variant isn’t showing up in economic data yet, but it could.
“The problem is that these supply chain problems are now more difficult to resolve,” she said. “It could also dampen demand. … I wouldn’t be surprised if people refused to go into restaurants. “
The Centers for Disease Control and Prevention was expected to recommend Tuesday that vaccinated people should also wear masks indoors in areas with high rates of Covid transmission. The real risk to the economy is that the proliferation variant will slow down reopening or force schools to close.
Swonk said the Fed is talking about a throttling and some members are encouraging it sooner rather than later. But if the Covid variant begins to affect the economy, that could affect the discussions.
“It could change your taper timeline. I don’t think they want to change anything because they want to see what happens first,” she said. “The most important thing about tapering is, can the financial markets work while they’re going through this? Much will depend on whether we follow a UK model and get to the point where it’s more manageable again.”
Jim Caron, head of global macro strategy at Morgan Stanley Investment Management, said he expected Powell to sound like it did at his recent Congressional hearing on business.
“Just like he said in his semi-annual statement: ‘Things are getting better, but we may still be a long way from making significant progress,'” said Caron. “I think they’ll say they talked about the tapering, but he’ll be back with no decisions yet to be made.”