In a policy statement released this week, the Federal Reserve announced, as widely expected, that they will begin to taper the rate of new asset purchases beginning later this month.
They left the benchmark fed funds rate unchanged near zero. The pace of tapering will start out as the Fed described in the minutes of the previous FOMC meeting. They will reduce the rate of Treasury bond purchases by $10 billion this month, to hit approximately $70 billion worth of net new purchases. They will reduce the rate of mortgage-backed security purchases by $5 billion per month to hit about $35 billion this month.
The policy statement also announced that the Fed will step down purchases at the same rate in December. It will be telling to see if the Fed either increases or decreases the rate of tapering next year. The Fed intends to end net new asset purchases by around the middle of next year. If inflation is a worry, they could increase the pace of tapering so that they could pull the schedule for interest rate lift-off forward.
Conversely, they could reduce the rate of tapering if economic conditions next spring turn out to be softer than they currently anticipate. This could push interest rate lift off back into 2023 or later. The Fed still used the keyword “transitory” to describe factors influencing inflation. They acknowledged supply-demand imbalances stemming from the pandemic and the resultant economic closures.
According to the Fed’s policy announcement, the path of the U.S. economy depends on the course of the COVID virus. The vote on today’s monetary policy action was unanimous.
In his post-announcement press conference, Fed chair Jay Powell said that the summer surge in COVID-D cases and supply chain constraints held the economy back in the third quarter when real GDP increased at a 2.0 percent annual rate, but demand remained strong.
Powell declined to specify a particular goal or metric for employment. Powell anticipates that supply chain constraints will ease over time and allow inflation to return to the Fed’s near-2-percent long term goal. Powell defined transitory, with respect to inflation, as meaning that current high inflation will not lead to a permanently higher rate of inflation.
Powell avoided pre-committing the Fed to any schedule for interest rate lift off. But he did say that it was possible for the U.S. economy to reach the Fed’s employment goals by the end of next year, which could set the stage for interest rate lift off.
For now, we will maintain our forecast for interest rate lift off in December of 2022.
Market Reaction: U.S. equity markets reacted positively to the Fed policy announcement. The yield on the 10-year Treasury bonds increased to 1.59 percent. NYMEX crude oil futures eased to $80.14 per barrel. Natural gas futures increased to $5.82 per mmbtu.
Dr. Robert Dye is senior vice president and chief economist at Comerica. Daniel Sanabria is a senior economist at Comerica.