There is not yet 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 a little 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. 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 normalising 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.
FOMC Policy Announcement 28th July at 19:00BST/14:00EDT; Chair Powell Press Conference at 19:30BST/14:30EDT
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 normalisation, 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 combatting the pandemic, and there is increasing availability within the US.
LABOUR MARKET
Headline nonfarm 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 labour market normalisation may be a function of older workers opting to retire rather than rejoin the labour 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 labour market in the traditional way that labour markets tighten in recovery phases. Various economic releases and survey data have alluded to tight labour 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 characterisation. 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 characterisation. 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.