FOMC Preview: Here Comes The Taper
Ahead of today’s 2pm announcement by the Fed that it will taper QE by $15BN per month but “tapering is not tightening”, we have two previews – a whimsical one from DataTrek’s Nicholas Colas, who looks a the bigger picture of what may be Powell’s second to last post FOMC press conference, and a more technical and markets-driven one from Newsquawk.
We start with Nick Colas: the former SAC portfolio manager asks will this be Fed Chair Powell’s antepenultimate post-FOMC press conference? The reason why is because prediction markets have cooled modestly on his chances for reappointment. One thing is seemingly certain, however: Wednesday will bring an announcement on tapering. Markets have also pulled forward their expectations for a 2022 rate liftoff (led by Goldman which capitulated this week and pulled its liftoff prediction by more than a year to July 2022). That said, it is unlikely Powell will sound too hawkish – expect a lot of dollars in the Atlanta Fed swear jar as Powell uses transitory “dirty word” at least 20 times, and also numerous reminders that “Tapering is not Tightening” (spoiler alert: it is). After all, Powell should have learned his lesson on that score in Q4 2018.
With that in mind, here is Colas’ full preview of the 3 key issues to consider:
#1: Powell’s odds of renomination on PredictIt have been slipping a bit in the last 24 hours:
Since late October, his odds have bounced around between 70 and 74-76 percent. The highs here were in mid-September at 90 percent, before all the attention on personal trading by regional Fed presidents and governors. The lows were 61 – 63 percent right after that issue arose.
As of 5pm Tuesday, Powell’s odds of renomination stand at 65 percent. This comes in spite of the fact that Secretary Yellen just yesterday said that he has “certainly done a good job”.
The odds of Governor Brainard getting the nod remain low – just 27 percent – and Richmond Fed president Bostic is in third place at 14 percent odds.
Takeaway: we are solidly in the window when the White House typically announces new Federal Reserve Chairs, so the news could come in days at the shortest or a few weeks at the longest. Powell still has better than 50:50 odds, and we continue to believe markets will respond positively if he is renominated.
#2: With an announcement tomorrow on bond purchase tapering all but assured, the meat of the Powell press conference will center on his thinking regarding the timing of an eventual lift off in interest rates. Will this come right after tapering is done, or will the Fed take a wait and see approach?
The consensus expectations around tapering point to cutting purchases by $15 billion/month, starting in December. This would mean a July 2022 end to bond purchases, after which the Fed would be clear to start raising interest rates. Chair Powell and other Fed officials have said it makes little sense to bump rates before tapering is completely done.
Fed Funds Futures, however, point to the possibility that either tapering will start this month, or it will go faster than widely expected (4pm Eastern time prices quoted here):
Odds of higher Fed Funds rates in May 2022 than now: 29 percent (low, as you’d expect)
Odds for June 2022: 56 percent (slightly better than coin toss odds, one month before the consensus expects tapering to finish)
Odds for July 2022: 68 percent (a solid probability that the Fed will immediately move to tighten once tapering is done)
Odds for September 2022: 81 percent (high probability the Fed has moved at least once by then)
Takeaway: markets have priced in a fairly aggressive set of assumptions about the speed of tapering and rate liftoff. Powell has rarely been vocally hawkish in public settings since the start of the pandemic, so this seems like a good setup for stocks tomorrow.
#3: How Powell chooses his words about inflation and future US labor market conditions will be telling. Markets from Fed Funds Futures to TIPS to 2 – 5-year Treasuries have all decided that inflation is a growing problem and the Fed will act. This is how the Fed’s September communique characterized higher prices: “Inflation is elevated, largely reflecting transitory factors”. Look for “largely” to be replaced with some other word such as “mostly” or a similar characterization.
We will also be watching to see how Powell characterizes the US labor market because we (and most market participants) believe that the Fed must get an advanced look at the Employment Situation report when an FOMC meeting occurs on the same week the first Friday of the month. Last month’s report was disappointing (just 194,000 jobs added). If October’s data looks similarly weak, this may push Powell to sound more dovish given that the big news from this meeting (tapering) is inherently hawkish.
Takeaway/Final Thought: while it feels like it happened in a past lifetime, it really was just 3 years ago that global capital markets swooned as Powell followed a hawkish path on interest rates. He climbed down early in 2019, much to everyone’s relief. Having once tempted fate, we doubt he will be anxious to sound anything other than accommodative tomorrow especially given the announcement about tapering. And, of course, his hopes for renomination.
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And after that sparkling preview, here is a somewhat dryer one courtesy of Newsquawk, looking at what Wall Street expects Powell will say and do today.
The Fed is expected to for mally announce the tapering of its asset purchases at the November confab, while Chair Powell will be eager to distance the connection between tapering and future rate hikes off the zero lower bound. The existing USD 80bln/month of Treasury purchases, and USD 40bln/month of MBS purchases, are expected to be reduced by USD 10bln/month and 5bln/month, respectively just as we first said back in September.
In the Q&A, Powell will be cautious about giving too much away with regards to future tightening plans, stressing the independence of hike and tapering decisions, as not to upset the taper process. Powell could stress the flexibility of the taper, providing the Fed optionality to cut faster/slower depending on evolving conditions. The Fed’s tone on inflation will be closely followed amid no signs yet of “transitory” inflation and speculation on the risk of unanchoring longer-term inflation expectations from their 2% target, which would threaten the Fed’s accommodative policy stance.
Indeed, Powell and the rest of the FOMC have already begun expressing the possibility of more sustained price pressures, thus, the Nov FOMC remains a more formal outlet to express those inflationary risks alongside any adjustments lower to its idea of where full employment is.
TAPER: The existing USD 80bln/month of Treasury purchases, and USD 40bln/month of MBS purchases, are expected to be reduced by USD 10bln/month and 5bln/month, respectively; the NY Fed’s next monthly purchases schedule is due to be released on November 12th, and the taper implementation will likely be reflected in that update. Powell will likely note the flexibility of the taper, providing the Fed optionality to cut faster/slower depending on evolving conditions, but just how hard Powell emphasizes that will likely be a key signal for markets. On which, BMO’s strats believe that given the current market outlook they expect a hawkish reaction if Powell were to stress the fluidity of the taper. However, the analysts personally believe the risks of slowing the taper pace remain a strong possibility provided inflation prints do begin to recede as base effects/bottlenecks fade, and somewhat counter-intuitively if the market increasingly tightens financial conditions via rising yields the Fed will feel less pressure to tighten itself as markets will be essentially doing their job for them.
LIFT OFF: Powell will face assessment on the connection between tapering and eventual lift-off amid the continued aggressive market pricing for hikes (both in USD markets and abroad), the hawkish commentary from some regional Fed Presidents, as well as on the (yet to be proven) “transitory” nature of inflation as supply chains remain the limiting factor on growth. The Fed Chair will be cautious not to give too much away with regards to future tightening plans, stressing the independence of hike and tapering decisions, as not to upset the taper process. However, following ECB President Lagarde last week attempting to push back on market hike pricing to little effect, markets will be paying close attention to Powell’s assessment with money markets pricing in two hikes by the end of 2022. Goldman Sachs has itself just pulled forward its first rate hike projection to July 2022 followed by another in November 2022 citing expectations of core PCE remaining above 3% when it expects taper to conclude in June 2022.
TRANSITORY: Powell will face scrutiny on the increasing upside risks to inflation, with prospects that near-term rises unanchor longer-term inflation expectations from their 2% target, which would threaten the Fed’s accommodative policy stance to reach full employment; there remains a risk the Fed will have to walk back on its “transitory” argument. Indeed, Powell and the rest of the FOMC have already begun easing their tone on transitory, expressing the possibility of more sustained price pressures, thus, the Nov FOMC remains a more formal outlet to express those inflationary risks. The market continues to express risks of a more sustained period of inflation with 5yr inflation breakevens hovering around 3%, vs the inverted 30yr at c. 2.35%, while aggressive rate hike pricing next year conveys expectations that the Fed will have to act regardless of the employment/growth backdrop.
FULL EMPLOYMENT: If the Fed were to begin laying the groundwork for a rate lift-off, we can expect the FOMC to begin contemplating more strongly the possibility of its “full employment” mandate being at a level significantly lower than pre-COVID. Some of the more hawkish Fed members have already expressed this view, but it would have more weight if we were to get a nod to that at the Wednesday meeting after the official line from the FOMC has been that it expects many workers to come back off the sidelines. Even if there is no nod at this FOMC, those expectations could gain more traction come Friday if the October jobs report continues to show a fall in the unemployment rate alongside little evidence of workers out of the labor market stepping back in.
Wed, 11/03/2021 – 12:28