When the Fed emerges from its July meeting Wednesday afternoon, it may sound a bit more prone to keeping its ultra-easy policy in place than had been expected just a few weeks ago.
Federal Reserve officials are likely to express concerns about the rapidly spreading delta variant of the coronavirus. The market has been waiting to hear from the Fed on its plans to pare back its bond buying, the first major step in easing policy.
“This was supposed to be the meeting where they were really focusing on tapering,” said Mark Cabana, head of short U.S. rate strategy at Bank of America. “We think the market is going to end up hearing Powell sound neutral to dovish, at least from a rates market perspective, primarily because he’s going to keep talking about downside risks from Covid.”
The Fed releases a statement Wednesday at 2 p.m. ET, following its two-day meeting. Chairman Jerome Powell speaks to the media at 2:30 p.m.
Fed watchers expect officials to discuss tapering their minimum $120 billion monthly purchases of Treasury and mortgage-backed securities. They also expect it to move toward starting the unwinding by late this year or early next year.
Powell is also expected to stick to the view that the recent spurt in inflation is temporary, and that it will fade after a burst of pent-up demand spending and as supply-chain issues are resolved.
“In the FOMC statement, they talk about how the path of the economy is dependent on the path of Covid,” said Cabana. “Because of that, they’re naturally going to sound cautious. They’ll talk about tapering, but that will seem a formality given the fact they’re going to have to note there are increasing downside risks.”
The timing of tapering
The Fed has widely been expected to start seriously discussing the rollback of its bond purchases in late August at its Jackson Hole symposium or at its September meeting. The slowing of purchases were expected by some to begin before year-end.
But Cabana has been looking for the Fed to start tapering early next year, cutting back evenly on mortgage and Treasury purchases over a 10-month period.
“I think the resurgence of Covid pushes back on the notion that they’re going to start tapering in Q4,” he said. “I think we can all agree if we’re living with Covid longer than we thought, inflation becomes much less of a concern potentially because demand is going to wane. In that context, we think there’s really one thing … that matters in the world, and that’s the path of this virus.”
Cabana said he expects the Fed to signal at its September meeting that it will slow the bond purchases. He also looks for Powell to say the purchases do not have to be mechanical, and the Fed could slow or speed them if it wants.
The Fed is widely expected to take as long as a year to end the purchases, and at that point, it could be open to raising interest rates. In its forecast, it has two interest rate hikes in 2023.
“He’s going to have to admit that the delta variant makes uncertainty about the outlook much higher. He has to be very careful about the words he uses,” said Diane Swonk, chief economist at Grant Thornton. Economists said the delta variant is not yet showing up in economic data, but it could.
“The problem is it’s now harder to work through these supply-chain problems,” she said. “It may dampen demand as well. … I wouldn’t be surprised to see people cancelling going inside to restaurants.”
The Centers for Disease Control and Prevention was expected to recommend on Tuesday that even vaccinated people should wear masks indoors in areas with high Covid transmission rates. The real risk to the economy is if the spreading variant slows the reopening or forces schools to remain shut.
Swonk said the Fed is talking about tapering, and some members are encouraging it sooner rather than later. But if the Covid variant begins to impact the economy, that could affect the discussions.
“It could change their taper timeline. I don’t think they want to change anything yet because they want to see what happens first,” she said. “The biggest thing about tapering is, can financial markets stay functioning while they’re going through this? Much will depend on whether we can we follow a U.K. model and get to the point where it’s more manageable again.”
Jim Caron, head of global macro strategies at Morgan Stanley Investment Management, said he expects Powell to sound much as he did during his recent congressional testimony on the economy.
“Just like he said in his semiannual testimony, ‘Things are getting better, but we still may be a ways off from reaching substantial further progress,'” Caron said. “I think they are going to say they talked about tapering, but he’ll come back with no decisions have been made yet.”
Source: Economy - cnbc.com
