As universally expected, the Federal Reserve Open Market Committee (FOMC) kept the federal funds rate in the 0% to 0.25% range.
More importantly, it also announced a reduction in its Quantitative Easing (QE) asset purchase program from its current schedule of $80 billion per month in Treasuries and $40 billion per month in agency mortgage-back securities.
The taper schedule, which was hinted at in the minutes of the Fed’s September meeting, will reduce “the monthly pace of its net asset purchases by $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities” beginning later this month.
The FOMC justified its change in policy with an allusion to “the substantial further progress the economy has made toward the Committee’s goals since last December.”
The Fed has been vocal about separating the tapering of its asset purchases from a change in the policy rate. In the Fed’s view, there is still room for the economy to improve before it hikes rates, but that “progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment.”
All of the members of the FOMC voted in favor of the decision.
Key Implications
Expectations heading into today’s meeting were for a taper. The Fed delivered. This is the first step in the removal of pandemic-induced monetary policy support.
With the initiation of a taper in November, balance sheet expansion will likely be wound-down by June 2022. By that time, employment should be above pre-pandemic levels. With inflation set to remain above 2% target through next year, we see the Fed executing on rate hikes in the summer of 2022. As we mentioned in our report yesterday, given ongoing evidence of economic recovery, the time for patience is nearing an end.
The move today was well telegraphed. Equity markets, which are at all-time highs were little changed post-announcement. The same goes for the trade-weighted US dollar, which has been trying to test the 2020 peak over the last few weeks. On the other hand, U.S. Treasury yields are rising. The UST 5- and 10-year yields were up another four basis points on the announcement. We expect economic momentum to continue to improve heading into 2022, which should provide greater support for risk assets as well as a steady increase in bond yields.
