Fed Officials Started Their Taper Talk. That Doesn’t Mean the End of Easy Money
By Lisa Beilfuss
It’s official: Federal Reserve officials are talking about tapering monthly asset purchases sooner than they—and markets—had anticipated.
That doesn’t mean investors shouldn’t continue to count on dovish Fed policy.
“It’s clear the most meaningful topic in the minutes was the progress toward tapering and how it would be implemented,” says BMO Capital’s Ian Lyngen of the minutes released Wednesday from the Federal Open Market Committee’s June 15-16 meeting.
He notes there was debate on both the timing of any adjustment to the $120 billion in monthly Treasury and mortgage-backed security buys, as well as the breakdown between the buying “in light of valuation pressures in housing markets.”
That’s as “several others” favored an equal pace given that method is aligned with previous communication on the topic.
While members may have discussed tapering the purchases of mortgage-backed securities ($40 billion per month) sooner than the purchases of Treasuries ($80 billion per month), plenty are skeptical.
“We think this probably won’t happen, because home price inflation is set to slow sharply over [the second half of the year], thanks to falling home sales and adverse base effects,” says Ian Shepherdson of Pantheon Macroeconomics.
“We still think tapering will start in December and will be split proportionately between Treasuries and MBS,” he adds.
Overall, the minutes were more hawkish than April’s.
But as Shepherdson says, that was inevitable given forecast changes and the shift in the dotplot of officials’ interest rate expectations published in June.
To that point, investors should consider Fed officials’ discussion of ““substantial further progress,” which is the language Fed officials have been using to describe conditions necessary for policy tightening.
“Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data,” but “some” others want to wait for more data over the next few months before reaching a conclusion.
While “various” sounds like it represents more voices than “some,” economists say the Fed is likely to remain patient over the coming months as they try to ascertain whether labor market and other shortages pushing prices higher are transitory or more persistent.
“We think the voices pressing for patience will remain the most powerful,” says Shepherdson, adding that fall labor market data are key to how Fed policy will evolve later this year.
The minutes’ framing of the inflation debate should give investors further assurance that the Fed isn’t in a hurry to shift away from its extremely easy policy.
“A substantial majority of participants judged that the risks to their inflation projections were tilted to the upside because of concerns that supply disruptions and labor shortages might linger for longer and might have larger or more persistent effects on prices and wages than they currently assumed,” the minutes say.
They also say this: “Most participants observed that the largest contributors to the rise in measured inflation were sectors affected by supply bottlenecks or sectors where price levels were rebounding from levels depressed by the pandemic.
Looking ahead, participants generally expected inflation to ease as the effect of these transitory factors dissipated.”
The minutes go on to say: “if the effects of supply constraints proved to be transitory, as expected, then the inflation record from the past 25 years suggested the possibility that low underlying trend inflation…could cause inflation to revert to relatively low levels despite a strengthening economy.”
At the same time, participants called the ongoing economic recovery “incomplete” and noted that “risks to the economic outlook remained.”
Taken together, we read a still-dovish Fed that is sticking to its messaging around fleeting inflation, a labor market that has room to run and growth that will slow from this year.
The bond market seems to agree.
As Peter Boockvar of Bleakley Capital put it: “U.S. Treasuries didn’t blink,” hardly budging from where they traded before the minutes hit.
Stocks, meanwhile, hung on to gains.
The S&P 500 was up 0.4% while the Nasdaq 100 was 0.3% higher an hour after the release.
Investors should continue to look to August, during the Fed’s Jackson Hole Symposium, for more information around tapering.
Thomas Simons of Jefferies says he still expects an actual tapering announcement to come before the end of the year.
“Nothing in these minutes suggests anything different,” says Simons, calling the taper talk so far “not very productive” and “clearly just talk for now.”
The FOMC’s next meeting is July 27-28.
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