Fed leaves MMT island this summer
The next Federal Reserve meeting will conclude on 16 June. During the post-meeting press conference, we predict that Chairman Jerome Powell will indicate that QE tapering has been discussed, but it’s still too early to slow bond purchases (currently USD120bn/month). He will likely point to a growing debate about the true labour-market slack, and he could hint that a solid economic rebound could reduce it in coming months; but at this stage Powell is likely to indicate a patient stance given the uncertainty. Very generous unemployment benefits complicate the reading of labour-market data.
We continue to think the QE tapering signal will come at the Jackson Hole conference in late August, although the risk is that it comes earlier rather than later. The main risk hinges on wage data, which has shown upside surprise lately. If the trend persisted, and if household inflation expectations were also continuing to rise, that could render the Fed suddenly much less dovish given that data would go against its now-central case of transitory inflationary pressures. A reduction in bond purchases will mark a departure from the Fed’s de-facto current MMT-style policy (MMT: Modern Monetary Theory), by which the lines between fiscal and monetary policies have been blurred: indeed, the Fed has been indirectly monetizing a large share of the federal budget deficit.
Tapering would also mean a Fed becoming more uneasy with the rising inflation risk coming from such MMT-style policy, as well as with the potential financial imbalances that such policy generates, given current extremely loose financial conditions (which lessen market discipline and the right allocation of credit risk). A sign that the debate is shifting at the Fed towards a less ‘MMT naïve’ view, the Fed’s forecast for future interest rates (dot plot) could indicate one rate hike in 2023 (versus none in the March forecast). But money markets’ pricing is already indicating several rate hikes by late 2023, so it would be just the Fed catching up to market expectations.