Fed preview: Patience is the watchword
At its regular policy meeting to be concluded on 28 April, we predict that the Federal Reserve (Fed) will once again avoid sending signals about the coming reduction of its bond purchases, currently running at USD120 bn per month. This is despite now-tangible signs of a sharp improvement in US growth, itself linked to solid progress on vaccinating the US population and robust fiscal support from the federal government.
We predict Fed chairman Jerome Powell will once more refrain from giving a timeline for reducing and ending the Fed’s bond purchases, which continue at a monthly pace of USD120 bn/month. Nor do we think the Fed will move to tweak interest rates on banks’ excess reserves, given any move on this front could end up as a communication nightmare.
Our baseline scenario is that the Fed will start giving explicit hints in the second half of the year about tapering its asset purchases, with an effective start to tapering in Q1 2022. The Fed’s agenda could accelerate though, especially if payroll growth remains in the vicinity of 1 million per month throughout the current quarter. In fact, jobs will matter more than GDP in any tapering decision.
Money markets continue to doubt that the Fed will wait until 2024 to move up interest rates from the current 0-0.25% range, pricing in the first base rate hike at around December 2022. But we would tend to side with the Fed on this question, seeing the first rate hike in 2024.
The Fed’s ‘average inflation targeting’ strategy, adopted last year, implies the Fed remains tolerant of rises in inflation above 2%. But there are other dimensions to the Fed’s dovishness that go beyond mere inflation. For example, the Fed is also indirectly assisting in keeping borrowing costs low for the government but also for corporates. It is also watchful of socio-economic developments like unemployment among minorities, and soon could put more importance on the green energy transition. The stacking up of these new implicit mandates mean more protracted policy accommodation and the possibility that the Fed moves the goalposts further to avoid any serious monetary tightening.