Taper Time
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The Federal Reserve today announced the (much-overdue) start to tapering, which means it will continue to increase the size of its balance sheet, but not quite as fast.  Starting later in November, the Fed will reduce its monthly pace of asset purchases to $105 billion per month from the current rate of $120 per month.  In particular, the Fed will reduce Treasury purchases to $70 billion per month from $80 billion, while reducing mortgage-backed securities purchases to $35 billion per month from $40 billion. And the Fed expects to keep tapering Treasury securities by a further $15 billion per month (in the same proportions) starting in December.  At this pace, tapering would conclude in June of 2022, just in time for the market-implied first rate hike in July of next year.

Beyond the wording changes to the Fed statement to announce the tapering timeline, there were also changes reflecting updated views on the economic front.  For example, the Fed noted an additional tailwind for future activity as "an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation." 
It's also worth noting that the Fed tempered its "transitory" inflation talk.  In September, it had little doubt that the drivers of inflation would be temporary, stating the higher prices were "largely reflecting transitory factors." Today's statement hedged that comment, stating these factors are now "expected to be transitory."  In other words, their confidence that inflation pressures will ease any time soon is waning.

While pushed in his press conference to comment on rate hike timing, Chair Powell was very intentional not to make any commitments, but implied that if progress meets expectations, a rate hike could likely be appropriate in the second half of next year.  As per the usual line, future decisions are "data dependent," and faster or slower growth would shift that timeline.  When pressed on if the Fed is starting to fall behind the curve (given that they have been consistently low on inflation expectations up to this point) and how they would react if progress exceeds expectations, Powell simply reiterated that the Fed is prepared to accelerate (or slow) purchases if the data justify it.

At the end of the day, the Fed wanted to get the process towards normalization started, but the path this will follow in the year ahead remains uncertain.  There is no reason why QE should still be in effect today; tapering should have started, and ended, a long time ago.  In addition, the Fed's forecast on inflation is clearly too low.  And with the Fed not raising interest rates anytime soon, inflation is likely to turn out much more persistent than the Fed hopes. 

Brian S. Wesbury – Chief Economist
Robert Stein – Deputy Chief Economist

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Posted on Wednesday, November 3, 2021 @ 4:14 PM

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