“After five months of “talking about talking” about tapering, today we finally got the tapering details,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “All of that talk prepared markets for today’s announcement, which is why we didn’t see a big reaction out of markets. The Fed did a good job communicating its intentions to taper purchases but managing future rate hikes will be a tougher test .”
Regarding inflation, in the Fed’s statement and during the subsequent press conference, Chairman Jerome Powell acknowledged inflation risks are tilted to the upside but maintained that elevated inflation is “expected” to be transitory—the “expected” qualifier is new, however. Powell also mentioned the Fed can be patient before raising rates to address inflationary pressures but “won’t hesitate to act” if inflation is “materially and persistently” higher than expected.
Powell’s comments did nothing to change the market’s view on when rate hikes will take place. As shown in the LPL Research Chart of the Day, markets continue to price in at least two interest rate hikes next year with the first one coming after the July FOMC meeting. Interestingly, during the press conference, Powell identified the “second or third quarter of 2022” when the Committee expected the factors causing these elevated inflationary pressures to abate. With this timeline in place, if inflationary pressures remain stubbornly high into the middle of next year, markets may force the Fed to act.
Finally, while we got answers on how the Committee plans to reduce its bond purchases, what is still left unanswered is what the composition of the Committee will look like next year. Conceivably, we could see four new Fed Governors in 2022, including a new Chair and Vice Chair of the Committee, along with two new regional Fed presidents. We expect the Biden administration to provide clarity in the coming weeks on the Fed Governor roles—including the Chair and Vice Chair roles—but until those announcements are made, uncertainty remains. Moreover, if the Biden administration decides not to reappoint Powell, the credibility of the Committee’s patient approach to inflation comes into question. Our base case is that Powell will be reappointed but, with Washington D.C. involved, anything is possible.
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