The Fed is expected to formally announce the tapering of its asset purchases at the November confab, while Chair Powell will be eager to distance the connection between tapering and future rate hikes off the zero lower bound. The existing USD 80bln/month of Treasury purchases, and USD 40bln/month of MBS purchases, are expected to be reduced by USD 10bln/month and 5bln/month, respectively.
In the Q&A, Powell will be cautious about giving too much away with regards to future tightening plans, stressing the independence of hike and tapering decisions, as not to upset the taper process. Powell could stress the flexibility of the taper, providing the Fed optionality to cut faster/slower depending on evolving conditions.
The Fed's tone on inflation will be closely followed amid no signs yet of "transitory" inflation and speculation on the risk of unanchoring longer-term inflation expectations from their 2% target, which would threaten the Fed's accommodative policy stance. Indeed, Powell and the rest of the FOMC have already begun expressing the possibility of more sustained price pressures, thus, the Nov FOMC remains a more formal outlet to express those inflationary risks alongside any adjustments lower to its idea of where full employment is.
TAPER
The existing USD 80bln/month of Treasury purchases, and USD 40bln/month of MBS purchases, are expected to be reduced by USD 10bln/month and 5bln/month, respectively; the NY Fed’s next monthly purchases schedule is due to be released on November 12th, and the taper implementation will likely be reflected in that update.
Powell will likely note the flexibility of the taper, providing the Fed optionality to cut faster/slower depending on evolving conditions, but just how hard Powell emphasizes that will likely be a key signal for markets.
On which, BMO's strats believe that given the current market outlook they expect a hawkish reaction if Powell were to stress the fluidity of the taper. However, the analysts personally believe the risks of slowing the taper pace remain a strong possibility provided inflation prints do begin to recede as base effects/bottlenecks fade, and somewhat counter-intuitively if the market increasingly tightens financial conditions via rising yields the Fed will feel less pressure to tighten itself as markets will be essentially doing their job for them.
LIFT OFF
Powell will face assessment on the connection between tapering and eventual lift-off amid the continued aggressive market pricing for hikes (both in USD markets and abroad), the hawkish commentary from some regional Fed Presidents, as well as on the (yet to be proven) "transitory" nature of inflation as supply chains remain the limiting factor on growth.
The Fed Chair will be cautious not to give too much away with regards to future tightening plans, stressing the independence of hike and tapering decisions, as not to upset the taper process. However, following ECB President Lagarde last week attempting to push back on market hike pricing to little effect, markets will be paying close attention to Powell's assessment with money markets pricing in two hikes by the end of 2022.
Goldman Sachs (NYSE:GS) has itself just pulled forward its first rate hike projection to July 2022 followed by another in November 2022 citing expectations of core PCE remaining above 3% when it expects taper to conclude in June 2022.
TRANSITORY
Powell will face scrutiny on the increasing upside risks to inflation, with prospects that near-term rises unanchor longer-term inflation expectations from their 2% target, which would threaten the Fed's accommodative policy stance to reach full employment; there remains a risk the Fed will have to walk back on its "transitory" argument.
Indeed, Powell and the rest of the FOMC have already begun easing their tone on transitory, expressing the possibility of more sustained price pressures, thus, the Nov FOMC remains a more formal outlet to express those inflationary risks.
The market continues to express risks of a more sustained period of inflation with 5yr inflation breakevens hovering around 3%, vs the inverted 30yr at c. 2.35%, while aggressive rate hike pricing next year conveys expectations that the Fed will have to act regardless of the employment/growth backdrop.
FULL EMPLOYMENT
If the Fed were to begin laying the groundwork for a rate lift-off, we can expect the FOMC to begin contemplating more strongly the possibility of its "full employment" mandate being at a level significantly lower than pre-COVID. Some of the more hawkish Fed members have already expressed this view, but it would have more weight if we were to get a nod to that at the Wednesday meeting after the official line from the FOMC has been that it expects many workers to come back off the sidelines.
Even if there is no nod at this FOMC, those expectations could gain more traction come Friday if the October jobs report continues to show a fall in the unemployment rate alongside little evidence of workers out of the labour market stepping back in.