Begin the Begin: Fed Announces Start of Tapering

The Federal Open Market Committee (FOMC) announced the start of balance sheet tapering at a pace of $15 billion per month ($10 billion of Treasuries and $5 billion of mortgage-backed securities). They made no change to the fed funds rate, which remains near the zero bound. After reductions this month and in December, the statement noted that “the committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.” The bolded emphasis is mine, to highlight that the FOMC could change the pace of purchases if necessary … as such, we still don’t officially know the end date to the tapering process.

Rate hikes in 2H22?

The announced initial pace of the taper clears the way for the start of rate hikes sometime in the second half of the year; moving in line with the market having recently priced in two hikes by the end of next year. If the Fed maintains the pace of purchases laid out for at least the first two months of tapering, the process will conclude in eight months (June 2022). Assuming the Fed does not change its stated objective to finish tapering before initiating rate hikes, that would put the earliest rate hike to be in the second half. In Fed Chair Jerome Powell’s initial comments after the release of the statement, he said the tapering decision does not imply anything about raising the federal funds rate; saying the test for that is more “stringent.”

In terms of the topic-du-jour—inflation—the FOMC statement added two new mentions of supply challenges that were not in September’s statement. Specifically, it noted that “inflation is elevated, largely reflecting factors that are expected to be transitory” and that “supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.” They obviously decided not to retire the word “transitory,” even if they now realize that clearly means more than just a few months. Perhaps there was more than just subtlety to the change from September’s statement describing inflation as transitory, to today’s statement describing the contributing factors as transitory.

Wage growth has accelerated, as have inflation expectations; alongside a steady increase in the “stickier” components of inflation measures like the rents-based components. Fed watchers on the more hawkish end of the spectrum will likely up their criticism that the Fed is falling behind the curve.