A decision by year end and six (or so) month taper is the FOMC’s expectation, in line with Westpac’s view.
The FOMC’s September meeting communications met our expectations, with a near-term taper signalled without a formal decision being made.
While the Committee’s views on the immediate outlook have deteriorated between June and September because of the current delta wave, the 2021 GDP forecast revised down from 7.0% to 5.9% and the end-2021 unemployment rate projection up from 4.5% to 4.8%, the Committee’s confidence in the outlook from 2022 remains strong.
Indeed: growth in 2022 has been revised up from 3.3% to 3.8% and is seen above trend through 2023 and 2024 (2.5% and 2.0%); as a result, the unemployment rate is forecast to be back at its ‘full-employment’ level in 2022/23 (respectively 3.8% and 3.5%). This is why the Committee believe that if “progress continues broadly as expected… a moderation in the pace of asset purchases may soon be warranted”.
The questions that need answering are what is meant by “soon” and at what pace the taper will proceed. From Chair Powell’s press conference and the fed funds rate dot plot, December 2021, if not November, will see a formal decision on this policy, with Chair Powell clearly articulating in the press conference that the taper test for inflation has been surpassed and that for the labour market “all but met”. The decision between November and December will be determined by the strength of the September and October jobs reports. Regarding the pace of the taper process, he repeatedly looked to the middle of 2022 as a likely end point, giving a 6-8 month timeline (in line with our January to June 2022 expectation).
The updated fed funds rate dot plot confirms this is the view not only of Chair Powell but the Committee, with the fed funds rate now seen at 0.3% at end-2022 (essentially a split vote on a first hike) rather than the lower bound. This forecast change was not necessary, particularly as data has disappointed of late and given risks related to the delta wave. As per the economic forecasts above, it speaks to strong confidence in the recovery and an ability to begin normalising monetary policy without undue risk to the economy.
Looking at the long view for the fed funds rate, after a potential first hike in late-2022, the Committee sees a further three hikes in 2023 to 1.0% and another three in 2024 to 1.8%. This profile is in keeping with our established expectation of a fed funds rate of 0.375%; 0.875%; and 1.625% at year-end 2022-2024 respectively.
On this path to policy normalisation, two facts need to be recognised: (1) the FOMC do not expect to act pre-emptively or aggressively; and (2) at the end of 2024, the stance of monetary policy is still best characterised as accommodative.
Highlighting these points, while their immediate expectation for PCE inflation has been revised up from 3.4% to 4.2%, in 2022-2024 and the longer-run inflation is seen at target, with both the headline and core measures rounding to 2%yr. On the stance of policy, note that the FOMC expects the nominal fed funds rate to remain below their ‘longer-run’ neutral rate throughout and, in real terms, to be negative, with the fed funds rate below the rate of inflation to end-2024.
There are two implications of the above: (1) at or above-trend growth should be sustained into the long-run; and (2) risks of higher inflation and a consequent need to maintain a rate-hike bias beyond the current forecast period should remain in frame.
While we hold 1.625% as the most-likely peak for the fed funds rate for this cycle, we recognise the risk of further tightening proving necessary by maintaining a positive spread between the 10-year yield and the fed funds rate.
A final word on the US dollar. Currently the US dollar is pricing in a near-term adjustment of US monetary policy without fully recognising that other central banks will be acting at the same time, some in a more aggressive fashion than the FOMC. Most notable is the Bank of England/ ECB who respectively will end/ abruptly-reduce purchases in December and March. Arguably, global delta risks and current uncertainties in China’s property sector are leading the market to look through these near-term policy changes to the rate-hike cycle beyond which the US will almost certainly lead and Europe most definitely lag. The projections provided by the FOMC overnight are supportive of this status quo.
