- The minutes from the July 27-28 Federal Open Market Committee (FOMC) meeting showed that members view the economy as having made significant progress towards their policy objectives in recent months. The members of the Committee stated that “with progress on vaccinations and strong policy support, indicators of economic activity and employment had continued to strengthen.”
- FOMC members hedged their optimism, highlighting that there is more room to go on the recovery. That “activity in the service industries most adversely affected by the pandemic, such as in the leisure and hospitality sector, was rebounding as the economy reopened further but had not fully recovered,” and that in spite of recent job gains, “the household survey showed that the unemployment rate remained elevated at 5.9 percent in June, and the labor force participation rate and employment-to-population ratio were little changed in recent months.”
- On the balance sheet, Fed members opened up about just how close we are to a tapering announcement. Recall that the members need to be convinced of the economy’s progress towards maximum employment and price stability before they make a change to asset purchases. Here, the members stated that “the economy had made progress toward the Committee’s maximum-employment and price-stability goals since the adoption of the guidance on asset purchases in December. Most participants judged that the Committee’s standard of “substantial further progress” toward the maximum-employment goal had not yet been met.”
Key Implications
- That’s the sound of the tune changing. Fed members have been increasingly more confident in the progress shown by the American economy. And they should be. Economic growth is poised to overshoot its potential over the next several quarters, the labor market is heating up, and inflation continues to exceed expectations. This is why most members see rate hikes happening in 2023, and a growing chorus calling for them to start in 2022.
- Before that happens, an adjustment to the Fed’s Quantitative Easing program is right around the corner. With soaring equity prices, frothing home prices, and climbing debt levels, efforts by the Fed to push down interest rates and support risk taking behavior, are no longer warranted. The minutes today make us more confident in our call that a tapering to asset purchases will start as early as October.
- Even with emerging variants and risks to the outlook, we have the Federal Reserve pointing to a reduction in monetary support (tapering) and signaling to markets that a rate hike is not far behind. At the same time, inflation is hot and expected to remain elevated for the next couple of years. Even still, the U.S. 10-year Treasury yield is trading around 1.3%. That’s too low. To reiterate our recent Dollars & Sense, Something’s Gotta Give.
