December Flashlight for the FOMC Blackout Period

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Summary

The final meeting of the FOMC in 2021, to end on December 15, will leave a lot to talk about at this year’s holiday festivities. The highest inflation in a generation shows little or no signs of slowing down any time soon. Along with the rapidly straining labor market, the persistence of inflationary pressures has committee members rethinking where policy needs to be positioned to balance the current risks to the outlook.

Despite initially announcing plans to reduce asset purchases just five weeks ago, we expect the FOMC to begin reducing its asset purchases more quickly at its meeting next week. Specifically, we are looking for the FOMC to reduce purchases of treasury and mortgage securities at a rate of $ 15 billion and $ 7.5 billion per month, respectively, which would lead to purchases ending in April 2022 instead of June 2022, which is when it would. were achieved at the current rate.

FOMC members have struggled to convey that the decline in assets is not directly linked to the nutrient fund exchange rate, and that ending assets earlier is partly intended to give the FOMC greater eligibility in the coming year. That said, we expect a sharper downturn in the FOMC’s Summary of Economic Projections. It would not surprise us to see that the “point plot” indicates at least two 25-bp rate hikes in 2022, followed by three more increases in both 2023 and 2024. That would put the median estimate for the food finance target at the range. end of 2024 at 2.00% -2.25%. Although below the FOMC’s long-term estimated rate of 2.50%, this is above the current market price and could feel to some at the party that the punch is being removed.

The Base Is Laid for Faster Taper, but Omicron Deals Wildcard

At the conclusion of the FOMC’s Nov. 3 meeting, the committee announced that it would begin to reduce its rate of asset purchases. More specifically, the committee announced that it would reduce the $ 80 billion monthly rate of purchases of the treasury by $ 10 billion per month in November and December, while reducing the initial $ 40 billion monthly rate of purchase of backed securities (MBS) by 5 billion dollars a month. during the same period. If a decline continues at that rate, asset purchases would end in June 2022. However, the FOMC did not indicate how much it would reduce purchases after December, giving itself the flexibility to make adjustments “if warranted by changes in the economic outlook.” . ”

Since November 3, there have been some notable data developments as well as changes in how key Fed officials look at the outlook. First, inflation continued to surprise to the top. The consumer price index rose a sharp 0.9% in October, pushing the one-year change to a 30-year high of 6.2%. Core PCE inflation at 4.1% is now more than double the FOMC target (Figures 1 & 2). The November CPI report, to be released this Friday, will take a further look at inflationary developments. We expect another uncomfortable print for the Fed, with a 0.8% monthly rise pushing up prices to a year-on-year rate of just a staggering 7%.

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But beyond any month’s data, FOMC members have indicated that the strongest inflation in a generation is likely to take longer to decline than previously thought. In President Powell’s prepared remarks to Congress last week, he stated that “now it looks like factors pushing inflation up will continue well into next year,” and that it was time to step back using “transitional” to describe the current super target. . inflation.

The labor market has also made significant strides towards full employment during the meeting period. Although the November payrolls have weakened, a solid gain in October and upward revisions to data from previous months show 1.1 million more employees in the books since the most recent FOMC meeting ended. In addition, the unemployment rate declined rapidly, falling 0.6 points, even as labor force participation rose to a new COVID era high (Figures 3 & 4). While there is still room for improvement in employment, the stricter labor market is reducing the tension between price stability and the FOMC’s employment targets.

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Recent developments in inflation and the labor market have led to a chorus of FOMC members marking the possibility of reducing asset purchases more quickly. The laundry list of officials includes more hawk members, such as Waller (Board), Bostic (Atlanta), Bullard (St. Louis) and Mester (Cleveland), but also more dovish members, Clarida (Board) and Daly (San Francisco). Even President Powell recently stressed the possibility of a faster rate of decline at the next FOMC meeting. In particular, his comments came after the appearance of the Omicron variant became known. We believe that if Powell had viewed Omicron as a significant threat to the prospect at that time, he would have stopped saying that it would have been appropriate to discuss finalizing purchases a few months earlier at the December meeting.

Our assumption, therefore, is that the FOMC will announce plans to accelerate the decline in its assets at its meeting next week. Specifically, we expect the committee to announce that by January, it will purchase $ 45 billion in Treasury and $ 22.5 billion in MBS, i.e., reducing the monthly purchases of the Treasury and MBS by $ 15 billion and $ 7.5 billion, respectively. At that rate, assets would buy in April rather than June. However, if reports in the coming days show that the Omicron variant is becoming a greater threat to the economic outlook and / or the November CPI report paints a significantly kinder picture of inflation, then we could predict that the FOMC will launch any adjustments until its January 26 meeting. . In other words, accelerated narrowing is not a sure bet.

The Points Will Rise, But How Much?

Next week’s FOMC meeting will include the first update to the Summary of Economic Projections (SEP) from the September 21-22 FOMC meeting. As we have already discussed, much has changed in the economic outlook since then, and all eyes will be on the point plot as financial market participants try to distinguish the outlook for nutrient fund exchange rates once the narrow is complete. In the September projections, the midpoint for the end of 2022 sat directly between zero and one 25-bp rate (Figure 5). This was largely in line with market prices at the time. However, in recent months, market prices for 2022 tariffs have risen sharply. In this writing, markets have prices for about 66 bps of tension in 2022. Our best guess is that the updated points to be released next week will have an average projection of two 25-bp rates in 2022.

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By 2022, we doubt that the midpoint will change that much, although the distribution of participants could. The September projections showed a median of three rates in 2023 and three more in 2024. If the midpoint moves to two increases in 2022 and the 2023/2024 points continue to indicate three increases each year, the cumulative number of increases would put the nutrient funds target range at 2.00% -2.25% at the end of 2024. Maybe one more rate hike is sneaking somewhere above that horizon, but more than that and the midpoint would be at or above the “longer-term” point of 2.5%. We doubt that most FOMC participants want to signal that short-term rates may rise above the neutral rate here by far.

In addition to the points, the second most important SEP projection will be the FOMC inflation outlook. As it has done in past meetings, the FOMC will have to make a mark to market its 2021 inflation projections. The FOMC’s September average PCE inflation forecast for Q4-2021 was 3.7%, a figure that is already below the October reading of 4.1%. More interesting, in our opinion, will be the 2022 projections. The FOMC’s median core PCE inflation projection for Q4-2022 was 2.2% in September. Our current forecast is for 2.9% (Figure 6). We doubt that the updated median projection will be as high as our forecast, but something in the 2.4% -2.7% seems credible to us. Revisions to the projections for real GDP growth and the unemployment rate should be more modest and are unlikely to garner as much attention as changes to the points and inflation outlook.

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Even the Fed has a lot of jobs to fill

Shortly before Thanksgiving, President Biden announced his intention to appoint Jerome Powell for another term as Chairman of the Board of Governors. President Biden has also announced that he will appoint current Governor Lael Brainard as Vice President. The timing of their confirmation votes has not yet been announced, but we suspect they will be confirmed sometime in the first weeks of January. Assuming they are both confirmed, and Richard Clarida, whose term expires in late January, is not nominated for another term, there will be three vacant seats on the seven-member Board of Governors. One of these three vacancies would be the Vice President of Oversight, whose duties include leading the regulatory measures of the Federal Reserve’s financial system. Media reports suggest that President Biden will nominate candidates for at least some of these seats in the coming weeks, but so far no one has been officially named. We doubt that any of these potential candidates would materially change our outlook on monetary policy, but as the situation evolves, we will update our readers accordingly.

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