The Federal Reserve’s so-called banging speech could keep markets cutting edge through summer


People walk past the Federal Reserve building on March 19, 2021 in Washington, DC.

Olivier Douliery | AFP | Getty Images

The Federal Reserve faces a big summer ahead as markets search for clues as to when the super-easy policy measures put in place during the pandemic may finally start to dissipate.

Investors got their first indication this week when the minutes of the last central bank policy meeting included a discussion in which some members said it would soon be time to talk about cutting at least the one of the main tools the Fed uses to guide the economy.

The critical part of the meeting summary released on Wednesday noted that “a number of participants suggested that if the economy continues to move rapidly towards the Committee’s goals, it may be appropriate at some point in future meetings to begin to move forward. discuss a plan to adjust the pace of asset purchases. “

In market ears, the passage sparked talk of “tapering,” a word that usually makes investors nervous because it means the Fed will start cutting the roughly $ 120 billion in bond purchases it is making. each month. This program, also known as quantitative easing, has been the backbone of markets, which have steadily risen and shrunk with the size of the central bank’s balance sheet for over a decade.

Fed officials have promised plenty of warnings before any real reduction occurs, so the presence of such a speech at the April meeting likely sent the first signal that a buying cut is on. the table, with more information to come in the coming months.

“Everyone knows that the critical period is going to arrive by the fall,” said Jim Paulsen, chief investment strategist at Leuthold Group.

The market consensus is that the Fed will start dropping the breadcrumb trail by the time central bankers meet in August at their annual symposium in Jackson Hole, Wyoming, presented by the Kansas City Fed.

That process has already started: Dallas Fed Chairman Robert Kaplan said on Thursday that tapering talks should start “sooner rather than later,” and Philadelphia Fed Chairman Patrick Harker on Friday used the same expression to describe its position.

A brief history of tapering

Jackson Hole highlight will be President’s keynote address Jerome Powell, who used the event last year to chart a revolutionary new policy on how the Fed approaches inflation.

This year, Powell will take a look at what are expected to be accelerated price pressures that exceed the Fed’s 2% mandate and have caused some market pressure to tighten policy at least a bit to avoid future problems.

“I’m not sure the Fed will have to do much [tapering], although I probably would, “said Paulsen.” I would cut back anyway, because I don’t see what a benefit there is now to having all that excess liquidity out there. If that doesn’t create runaway inflation, it really doesn’t matter. Why leave it lying around? “

The markets reacted negatively to the tapering signal sent by the Fed but have since changed course.

Commodity prices, which fell for most of 2021, were mostly lower, while government bond yields also weakened. The market sell-off was brief on Wednesday and stocks rose on Thursday and Friday.

These moves provided some comfort that a repeat of 2013’s “taper tantrum” may not be in the cards.

In fact, the tantrum that year wasn’t even really a tantrum.

After then-President Ben Bernanke told a congressional hearing that a cut in buying was coming – the eighth anniversary is Saturday – the benchmark 10-year Treasury yield soared by one percentage point over the next four months.

The S&P 500 gave up 5% before turning around and actually ended the year with what remains the best gain of the 21st century. The movements of stocks and bonds happened before the Fed actually cut its buying rate, at a rate of just $ 10 billion per month.

“The 2013 Taper Tantrum happened before anything ‘happened,’ said Nick Colas, co-founder of DataTrek Research, in a note earlier this week.

This is why it is essential for Powell and the Fed to communicate well, and why they should prepare for a modest reduction in purchases soon.

A possible schedule

Central bankers so far have stuck to a scenario that says the recent rise in inflation will last for a few months and then fade away, and the success of how they manage to unwind the massive easing that has been in place since March 2020 is vitally dependent on of the economic history that unfolds in this direction. fashion.

“I think the Fed will do it right, because they agree with our view that the upside risk of inflation is transient,” said Alejandra Grindal, chief international economist at Ned Davis Research.

Grindal predicts that the Fed will announce its reduction intentions between Jackson Hole and the November Federal Open Market Committee meeting, a timing a little later than what other central bank watchers expect, but largely in line with the move to this year.

“Then we expect the cut to start in 2022. It will take the Fed about a year to go through the cut process. Then we expect to see a rate hike in 2023 at the earliest, but it could be. as late as 2024, “she said.

Economists and most Wall Street strategists accept the Fed’s rhetoric that the inflationary pressures that pushed the Consumer Price Index up 4.2% in April will likely subside once the problems with the supply chain and base effects from 2020 will dissipate.

However, the question remains whether the central bank can stage a soft landing from stimulus measures that have seen benchmark lending rates cut to near zero and a nearly $ 4 trillion balance sheet expansion. from the Fed.

The last time the Fed tried to cut assets and raise rates, the results weren’t good. Powell’s claims that the bankruptcy was on ‘autopilot’ and that the Fed was still a long way from stopping what in 2017 and 2018 had been a series of quarter-point rate hikes sparked an uprising in markets when economic growth has slowed.

This further raises the stakes for this summer’s communications efforts.

“They haven’t done the perfect things in the past,” Grindal said. “The point is, the Fed is learning from the past.”

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