At his last post-policy-meeting press conference on June 16, Federal Open Market Committee Chair Jay Powell said that the time for “talking about talking about” a wind down of Federal Reserve asset purchases was over.
In the official minutes from that policy meeting, released on July 7, we see confirmation that the Fed collectively is indeed talking about when and how to start decreasing asset purchases. These bond purchases, currently at the rate of about $120 billion per month, are helping to provide liquidity to financial markets and are putting downward pressure on interest rates.
We expect to see a more active discussion within the FOMC about tapering asset purchases, along with more public commentary, at the upcoming FOMC meeting over July 27/28. In the upcoming commentary, we expect the Fed to confirm that they will begin to decrease the rate of asset purchase before the end of this year. Right now the window for the eventual start of tapering looks like it begins by the end of September and extends through the end of December.
If the Fed is concerned about an overheating economy and accelerating inflation, they could begin to taper by the end of September. They could use their annual Jackson Hole conference at the end of August to signal an end-of-September or October taper. If they feel less concerned about inflationary pressure, they could wait until the mid-September FOMC meeting to announce that they will begin to taper by the end of December. Much depends on how the Fed judges inflationary pressure.
The minutes from the June FOMC meeting showed that the Fed staff near-term outlook for inflation was “revised up markedly.” Still, the staff outlook called for inflation to gradually decrease in the coming months as production bottlenecks and supply-chain constraints ease. But the staff at the Fed does not vote on policy actions. It is the committee participants, the Board of Governors and the regional Fed presidents, that vote on monetary policy.
In the minutes, meeting participants noted that the recent rise in inflation was more than they anticipated earlier this year. Several meeting participants (we don’t know exactly which ones) anticipate that supply chain limitations and input shortages will put upward pressure on prices into next year. Still, some participants noted that measures of longer-term inflation expectations had remained in ranges consistent with the Fed’s long-run inflation goal.
Related to the debate within the Federal Reserve about inflation and asset purchases is Federal Reserve interest rate policy. We expect the Fed to follow the Bernanke playbook of a first-in/last out sequence for unwinding its policy tools. The first tool engaged to combat the depressive effects of pandemic-related social mitigation policy was dropping the fed funds rate to near-zero. The second tool utilized was asset purchases.
The third set of tools engaged were special programs. The Fed has already begun to unwind its special programs. They are discussing how to unwind asset purchases. We expect them to wait until they have established their game plan for winding down asset purchases before they turn their full attention to the timing and trajectory of interest rate lift-off from the zero lower bound. It is telling that in the minutes of the June FOMC meeting, several participants were concerned that low interest rates were contributing to elevated house prices and that high house prices might pose risks to financial market stability.
For now, we feel comfortable maintaining our interest rate forecast of the last several months which shows a 25 basis point increase of the fed funds rate coming at the end of 2022 followed by another 25 basis point increase in early 2023. This timing would allow the Fed to gradually wind down asset purchases from the end of this year through mid next year, and then prepare financial markets for a rate hike by the end of next year. That said, we are mindful that the best laid plans (and forecasts) of mice and men often go awry. Much will depend on the persistence, breadth and velocity of the current surge in U.S. and global prices.
Robert Dye is vice president and chief economist for Comerica. Daniel Sanabria is senior economist for Comerica.