Two Times the Taper, and a Pivot in a Pear Tree
In its last official statement of 2021, the Federal Reserve announced they would double the pace of tapering from $15 billion/month to $30 billion/month starting in January. This is in line with what most expected, and the immediate market reaction was positive (recall that the market hates surprises and so does Jerome Powell, in my opinion).
This puts them on track to end the asset purchasing program in March 2022, and begs the question: given the dual threat of inflationary pressures and a labor market that hasn’t yet fully recovered, when will rate hikes begin?
Frosty the Jobsman
On balance, Jay Powell said we’re in good shape and on the right path, but the FOMC still has a watchful eye on the labor market. The statement included this quote, “With inflation having exceeded 2 percent for some time, the Committee expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment.”
My interpretation: rates aren’t rising until the FOMC is more comfortable with the state of the jobs market, and tapering should be sufficient at controlling inflation in the meantime.
I also think the message was an attempt to reduce fear that the Fed would slam on the brakes, and reassure markets that they would tap the brakes instead. It seemed to work.
Hawk! The Herald Angels Sing
However, we can’t ignore the changes in the dot plot (a chart of where FOMC members think the Fed Funds Rate should be in future periods), which shows a materially more hawkish outcome compared to September’s statement. Specifically, now 10 of 18 members see three rate hikes in 2022, compared to zero members who saw three hikes in the September statement.
Although this seems like a lot, it would still put the lower bound below 1% by the end of next year, which is pretty darn low by historical standards, and a scenario I think markets can manage just fine. I do think the Fed was late on retiring the word “transitory” from its inflation narrative, but I’m comfortable with the trajectory they seem to be on.
The one spot that I don’t quite align with is their estimate for inflation–coming down from 5.3% in 2021 to 2.6% in 2022. That feels a bit aspirational and it undershoots my estimate for next year, which would stay closer to or above 3.0%. The “sweet spot” for markets is historically a CPI between 1-3%, and anything above 3% tends to become a problem. This is the biggest risk I see and something to keep a close eye on.
Leadership will shift, and rotations from high growth stocks into reasonably valued stocks with solid fundamentals should finally stick. This will be a bumpy path to and through tightening, but right now, I’m betting on a successful transition. If we can’t handle it now, when can we?
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