FED Announces Start of Tapering : Implications

Begin the Begin: FED Announces Start of Tapering

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 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). 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."*

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." Wage growth has accelerated, as have inflation expectations; alongside a steady increase in the "stickier" components of inflation measures like the rents-based components. Specific to inflation and the time frame associated with "transitory," Powell said the Fed believes inflation will wind down by next year's second or third quarter. For now, he says there is no evidence of a wage-price spiral: "We don't see troubling increases in wages.

In his introductory comments, Powell stressed the recent slowdown in job growth and the weakness in the auto industry courtesy of global semiconductor shortages; as well as the hit to travel and leisure spending. Powell did stress that demand "has been very strong this year," with healthy financial positions a contributing factor. 

From an equity market perspective, the initial reaction was positive; but stocks may have periods of volatility if economic data and/or the trajectory of inflation leads to an adjustment by the Fed of either the pace of tapering and/or the timing of initial rate hikes.

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