The Federal Reserve isn’t ready to take its foot off the stimulus gas pedal just yet, but that soon might change.
If the economic recovery continues to progress as expected, the Fed “judges that a moderation in the pace of asset purchases may soon be warranted,” according to the bank’s policy update published Wednesday.
This raises the prospects of a November announcement that it will step on the brakes. But even if such a move was delayed until December or January, it wouldn’t matter much to markets, which have already priced in a policy change, said Seema Shah, chief strategist at Principal Global Investors, in emailed comments.
The Fed could also lift interest rates as early as next year, according to updated projections, as opposed to waiting until 2023 as previous forecasts called for.
Taper time
When the pandemic started to wreak havoc on the US economy in early 2020, the Fed stepped in, slashing interest rates to near-zero and committing to buying $120 billion worth of Treasury and mortgage-backed securities every month. These purchases will be rolled back soon, it seems, in what is referred to as a “taper.”
It’s the Fed’s job to keep prices stable and achieve maximum employment. Over the past months, Powell had said that more progress was needed on those fronts until a change in policies is warranted. But now his tone has changed: While the test for inflation is already met, the test for employment is “all but met,” Powell told reporters during Wednesday’s press conference.
“For me it would not take a knock-out great [September] employment report,” Powell added, even though other members of the policy committee still wanted to see further improvements.
Investors have long expected the Fed to clamp down on its monthly stimulus as the recovery was coming along nicely over the summer. But a disappointing August jobs report pushed those expectations back. Wednesday’s announcement was thus in line with what investors predicted and the stock market continued its rally after it was published.
Roadblocks ahead
There are still a few hurdles that the economy, and the market, need to overcome.
In Washington, the debt ceiling debate is heating up as lawmakers try to find a way to keep the government from running out of cash.
“It’s just very important that the debt ceiling be raised so that the United States can pay its bills when they come due,” Powell said, adding that the damage to the economy and financial markets would be severe if there were a default. Nobody should assume the Fed could fully protect the economy against such a failure, he added.
Meanwhile, the recovery has hit some roadblocks recently as the Delta variant is leading to more infections and affecting people’s willingness to be around others.
And as many economists began to factor the Delta effect into their winter forecasts for the economy, so has the Fed. Its projections see lower economic growth for 2021 with gross domestic product rising 5.9%, compared with the 7% it projected in June. The growth rate for 2022, however, was revised upwards to 3.8% from 3.3%.
Similarly, the Fed now expects unemployment to be slightly higher – at 4.8% – than previously thought at the end of this year. Similarly, inflation is also will likely be higher by year-end than projected in June, as it’s taking longer for bottlenecks and shortages that drive up prices to abate. The personal consumption expenditure index, which is the Fed’s preferred measure of inflation, is expected to be at 4.2% for the year rather than 3.4% previously forecast.
Spikes in inflation over the summer fueled the market view that the Fed would soon reign in its easy-money policies sooner rather than later to keep the economy from overheating.
