Summary: as Newsquawk recaps, summarizing the broad sellside consensus going into today’s FOMC meeting, there is still not enough information for the Fed to cast judgement on whether the ‘substantial further progress’ threshold for pivoting towards tighter policy has been met. Indeed, the Fed is unlikely to get clarity on these questions until later this year, or even into next year. Accordingly, the July FOMC may be premature for the Fed to officially signal any taper timeline, or indeed what the configuration of the scaling-back of asset purchases will look like, especially since there are no new dots or projection materials due today.
Therefore, traders will be listening to the tone of the Fed statement and subsequent press conference from Chair Powell on whether new variants of the coronavirus are at a stage where Fed officials are concerned enough to push out normalizing policy. The Fed will likely continue to frame the recent upside in inflation as transitory, but any suggestion that it could be something more persistent would likely be a trading event.
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With that in mind, earlier today we laid out one take why despite nobody expecting a “clear catalyst” from today’s FOMC meeting, the extremely flat curve means that the bias going into 2pm’s Fed announcement is for steepening: a modestly hawkish view. Taking the other side is Bloomberg commentator Vincent Cignarella who writes that while investors are betting the Fed will offer some clarity on taper talk with some hoping for guidance on when bond purchases will eventually be pared down, recent data suggest the Fed can be more patient and given expectations, the asymmetric risk for U.S. assets, sans the dollar, is to gain.
Cignarella first shows that weekly jobless claims back on the rise. With jobs being the main focus of Fed policy, it’s unlikely to be given a date on tapering just yet.
The other side of the Fed’s mantra is also feeling less pressure. Inflation on a month-over-month basis may be slowing, which is another reason for the Fed to keep its powder dry.
Even consumers are slowing purchases of big ticket items, which is yet another indication of caution as extra federal stimulus nears an end.
Lastly, there is potential for the end of forbearance on mortgages, rents and student loans to eat away at disposable income and slow personal spending.
As Cignarella concludes, based on everything Chair Powell has said so far, being behind the curve and not rushing to undermine economic growth is where the Fed prefers to be. That suggests the Fed will not give any substantial indication of when tapering will actually begin giving equity and bond bulls a pleasant surprise.
Indicatively, Goldman agrees, and in his FOMC preview, Goldman’s Jan Hatzius writes that Chair Powell said last week that the substantial further progress in the labor market required for tapering remains “a ways off,” implying that the FOMC is unlikely to deliver the first hint about tapering today. He adds that “the spread of the Delta variant and the market anxiety about the outlook expressed by the decline in Treasury yields have strengthened the case against pulling back on accommodation preemptively.”
Of course, not everyone will agree as some FOMC participants are clearly eager to start tapering in order to regain flexibility over interest rate policy sooner in case high inflation proves more persistent than expected. But, Goldman notes citing “the spirit of the Fed’s new framework, which calls for waiting for realized improvement in the data instead of acting preemptively”, the bank would be surprised if the leadership backtracked on that principle now. After all, while the expiration of federal unemployment benefits seems likely to have a large impact on the labor market, it initially seemed equally intuitive that vaccination would be a more transformative event for the labor market than it has been so far, reflected in the somewhat disappointing decline in the unemployment rate from 6.3% in January to 5.9% in June.
So what does Goldman think the Fed will announce today?
According to Hatzius, the FOMC will use the July meeting to continue its discussion of the pace and composition of tapering, and Goldman continues to expect the FOMC to taper at a $15bn per meeting pace, consisting of $10bn cuts to UST purchases and $5bn cuts to MBS purchases. At that pace, it would take eight meetings or one year to end asset purchases, so that if the first taper announcement comes in December 2021, the last taper announcement would come in November 2022. The FOMC would then want to take a pause for a couple of meetings, which would put rate hikes on the table around March 2023.; Goldman is still forecasting the first hike in 2023Q3.
What about the tapering split between Treasury and RMBS? After all, as several outlets have reported, several FOMC participants favor phasing out the MBS purchases faster. Indeed, the June minutes noted that they “saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets.”
Here, Goldman is quick to note that the Fed leadership appears to be pushing back against this proposal. Both Powell and President Williams have emphasized that MBS purchases support financial conditions broadly, not exclusively in the housing sector, and that the Fed’s MBS purchases are not the prime driver of the boom in home prices. Many Fed officials will also be reluctant to set a precedent of actively tweaking the composition of purchases in response to sector-level developments, which would risk unintentionallyimplying that the purchases are intended to target credit to a specific sector of the economy.
The most plausible alternative Goldman can see to its $10bn UST / $5bn MBS pace would be a $10bn UST / $10bn MBS pace. This would achieve a faster phase-out of MBS purchases, and would provide an implicit option to maintain the $20bn total pace of tapering by doubling the pace of UST tapering after the MBS purchases ended, which would shorten the taper period from eight meetings to six. This flexibility might appeal to participants who are not particularly worried about the impact of MBS purchases on the housing sector, but would value the option to gracefully accelerate the taper if inflation surprises to the upside.
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Goldman’s view aside, we go back to Newsquawk’s breakdown of key considerations heading into today’s FOMC:
DELTA RISKS: New COVID variants have been cited as the primary investor concern in Deutsche Bank’s June survey, followed by inflation and economic growth; other recent investor surveys paint a similar picture. The delta fears have sent a bull-flattening bias into the Treasury curve, as it threatens to lengthen any economic normalization, which will in turn influence how inflation and growth dynamics within the US (and globally) play out. With that said, while the delta risk can alter the path of monetary policy ahead, it is unlikely to significantly change the path for a taper announcement, analysts say, which is likely to be announced before year-end and implemented early next year, and run over the course for a year or so. Expectations of when the Fed will raise rates, however, are still being refined — with many arguing that the taper is more-or-less priced in by the market (subject to a knee-jerk reaction on the actual announcement, however), a bigger influence on market price action will be a sharpening of rate hike expectations. If the Fed were to highlight concerns on new variants, it would allude to staying accommodative for longer, which would likely lend support to the 5yr sector along the Treasury curve, and likely steepen out the long end of the curve, which may result in the 5s30s curve steepening. The Fed could, of course, borrow from communications earlier in the year, however, where it saw an uncertain near-term outlook but was very bullish on the medium-term prospects for the economy, and this optimism — if delivered with any degree of force — may offset any near-term delta fears, particularly since vaccinations are still seen as an effective way of combating the pandemic, and there is increasing availability within the US.
LABOR MARKET: Headline non-farm payroll data has been encouraging, however, analysts continue to cite concerns at the slow pace by which the participation rate and the employment-population ratio have been picking up; this will allow Fed Chair Powell to continue to argue that the ‘further substantial progress’ benchmark has not been met. Some Fed officials have suggested that the slow labor market normalisation may be a function of older workers opting to retire rather than rejoin the labor force as the lockdowns were lifted, but the extent to which new variants are posing headwinds to workers re-entering the workforce is yet to be answered. Some analysts argue that this poses some questions over the narrative about the tight labor market in the traditional way that labor markets tighten in recovery phases. Various economic releases and survey data have alluded to tight labor conditions, and this is likely to lead to some wage inflation. However, as the pandemic progresses, the question is how sustainable this worker pricing power will prove to be, another question that is not going to be resolved any time soon.
INFLATION: The Fed has been framing the recent upside in price pressures as transitory, and despite the upside surprise within the June CPI report, the FOMC will likely continue with this characterization. But investors are asking what it would take for this inflation to become something more than just ‘transitory’. The key for traders, however, is how the Fed describes it since the central bank will conduct policy based on its characterization. We therefore look to this week’s FOMC to see if there is any wavering in its ‘transitory’ description — if policymakers begin to signal that there is an underlying shift, and inflation is becoming more than just transitory, investors may start to refocus on reflation. This is not a line that policymakers will be desperate to jump into, but may be augured by broader price pressures beyond the ‘transitory’ categories like used car prices, or categories that benefit from lockdowns being lifted. Once again, a definitive answer will not be available on this issue until at least Q3/Q4 this year, perhaps even next year, so it is unlikely that the Fed/Powell will get drawn too deeply into this.
TAPERING: It may be too soon for the Fed to signal any imminent tapering of asset purchases, currently running at a clip of USD 120bln/month. Instead, markets are of the view a hint will be forthcoming at the Jackson Hole Economic Symposium at the end of August, before an official announcement at either the September meeting, or another in Q4, before beginning implementation in the early part of next year. There is an expectation that the Fed will roll back purchases by around USD 10bln/month, implying a tapering process that lasts for around one year. The parameters of the tapering are yet unknown, and there is an argument that the Fed might scale back MBS purchases (currently USD 40bln/month) before Treasury purchases (currently USD 80bln/month) due to the heat within the housing market. Some officials have also indicated a preference that the tapering process is not on ‘autopilot’, leaving the central bank with flexibility should it need to provide the economy with further accommodation. Another question is the sequencing of tapering and rate hikes — many have suggested that the taper announcement is priced into market prices, and it is the rate lift-off where expectations need refining. Once again, it is probably too soon for the Fed to be in a position to answer many of these questions definitively, and therefore, no taper signal or even any outline of the configuration of scaling back asset purchases is likely to be seen at the July meeting, analysts believe.
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Finally, courtesy of Forexlive, here is a snapshot of several other key bank takes:
Morgan Stanley:
- FOMC statement to reflect upbeat current conditions laid out in Beige Book while continuing to point to COVID as a risk.
- Think now is time to talk tapering.
- Expect FOMC to debate pace and flexibility as well as relationship of tapering with rate hikes.
Citi:
- FOMC to strike a balanced tone, acknowledging COVID concerns while noting risks of high inflation being more persistent than expected.
- Detailed taper discussions and some decisions, but without deciding timing and pointing to future meetings.
Wells Fargo:
- No changes in policy nor hints on the timing of an eventual change. Without updated projections, the July meeting is about word games.
- Expecting FOMC to hold off on a formal announcement of tapering until its December 14-15 meeting, with purchases starting to be reduced in January of next year at a pace of $10B per month for Treasury securities and $5B per month for mortgage-backed securities.
- The market appears on board with a late 2021 announcement, which is key to avoiding another tantrum.
- Potential catalysts for earlier taper stem from inflation continuing to surprise to upside.
- Less appreciated is the risk that tapering will not be announced until 2022. The case here rests on the fading fiscal support and concerns over COVID due to variants or the duration of vaccine effectiveness, any of which could lead to a sharper slowdown in activity.
- FOMC might err on the side of supporting the labour marker and take a slower approach to adjusting policy.
UBS:
- Little news from the Fed this week: a repeat of the ‘taper is some ways off’ language from Powell’s mid-July Congressional testimony and possibly an indication that the Fed will be able to assess in coming meetings whether the economy is ‘on track’ to achieve the taper threshold.
Danske:
- It is one of the interim meetings without updated projections (including Fed dots). Do not expect Fed to send any new policy signals. Expect Fed to repeat that high inflation is mostly transitory and that labour market recovery has further to go still.
ING:
- While no Fed policy changes are expected, could hear more about tapering discussions that started in June. Volume surrounding likely to be turned up at Jackson Hole with risks remaining skewed towards earlier policy normalisation than currently signalled.
- Powell made clear in testimony to Congress he continues to believe inflation pressures are largely transitory and no pressing need to signal imminent shift in policy.
- After all, employment levels remain more than 6 million lower than before the pandemic started while the latest Covid wave adds another level of uncertainty that can be used to justify inaction.
Nordea;
- No decisions tonight as the Jackson Hole conference is likely to be utilized to debate the tapering process. The tapering decision is likely to be taken in September with a slowing purchase tempo from December and onwards.
Conclusion: The market mostly expects a non-event as the policy is to remain unchanged and without updated projections there will be more focus on the words and the press conference. There will be acknowledgement of tapering discussions, but no timeline. The Fed can use the Delta variant spread to keep its dovish stance and will reiterate that it expects inflation to be transitory and focus more on the labor market recovery. The meeting will be mostly a can kicking to the next FOMC meeting in September.
