Another step toward Fed tapering
The main message from the Federal Open Market Committee (FOMC) meeting on 22 September will likely be that a formal announcement on tapering the Fed’s monthly asset purchases will be made at the following meeting, on 3 November. This would be in line with previous signals from the Fed and in keeping with Chairman Jerome Powell’s wish to ‘do-no-harm’ as he seeks re-appointment.
Some regional Fed presidents will express their restiveness about current monetary policy through the updated ‘dot plot’ that will be unveiled next week. The new dot plot could show the median forecast for the first rate hike being brought forward to 2022 from 2023, as most regional Fed presidents are more worried about the inflation risk than Chairman Powell. Regional presidents have also become more uneasy about quantitative easing’s (QE) impact on housing prices and asset prices in general. They fear that the combination of zero rates and QE could nurture financial instability.
However, a focus on the dot plot tends to exaggerate the importance of regional Fed presidents’ views over the more dovish Board of Governors in Washington DC: the dot plot should not be taken at face value for future policy direction.
Given the Fed’s relatively relaxed position on inflation, our central scenario is still that the first hike in the Fed funds rate will only come in 2023, starting what we believe will be a very shallow rate-hiking cycle. Indeed, the Federal Reserve is, in our view, worried that ‘true’ tightening of policy could destabilise a financial system characterised by high levels of private and public debt. We also think the Fed will stick to the letter of its mission to achieve “maximum employment”.
The main risks to Powell’s very accommodative monetary-policy philosophy, which has strong echoes in the fashionable Modern Monetary Theory, is, first, that the labour market is already much tighter than he believes and, second, that inflation expectations become unanchored. While dismissed by Powell, economic agents’ inflation expectations are creeping up and deserve scrutiny.