The Federal Reserve said on Wednesday that it will begin reducing its monthly asset purchases this month, with plans to terminate them in 2022, signalling the start of its tightening cycle. However, it maintained its long-held belief that strong inflation would be "transitory" and would not need a rapid increase in interest rates, causing markets to label it a "dovish taper".
The market reaction was subdued immediately after the news, with the dollar sinking as US equities rose.
Taking $ 15B A Month Off The Table
The tapering of bond purchases will begin "later this month," according to the governing Federal Open Market Committee's post-meeting statement. The procedure will result in monthly reductions of $15 billion – $10 billion in Treasurys and $5 billion in mortgage-backed securities – from the present $120 billion in purchases made by the Fed.
The move was made "in light of the substantial further progress the economy has made toward the Committee’s goals since last December." according to the committee.
In recent weeks, the Treasury market has churned as investors upped their views that inflation would compel the Fed to hike rates sooner and faster than expected. Short-term interest rates have increased, flattening the yield curve before somewhat retreating.
- Investors, on the other hand, have largely commended the Fed for foreshadowing the taper
- In contrast, bond rates skyrocketed in 2013 during the so-called "taper tantrum" when then-Fed Chairman Ben Bernanke suddenly informed legislators that the central bank may halt the pace of asset purchases that had been propping up markets
Elevated Inflation, Growing Economy
Fed Chairman Jerome Powell stated that he anticipates inflation to continue increasing while supply difficulties persist, before beginning to fall around the middle of 2022. Here is from the FED's FOMC statement:
"With progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months, but the summer's rise in COVID-19 cases has slowed their recovery."
"Inflation is elevated, largely reflecting factors that are expected to be transitory. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors."
The statement also stated that the economy is projected to improve further, especially after supply chain concerns are handled.
"Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses."
- Economic activity is being capped by a resurgence of COVID-cases throughout Asia, further constraining global supply chains and economic growth
- After massive rounds of stimulus and the sustained inflation it created, central banks and governments start lifting the foot and start limiting their support in a gradual manner
- With the many uncertainties that still linger on the horizon, a gradual reduction in support through a "dovish tapper" might be the only way to exit the post-pandemic chaos
- This would avoid destabilising credit markets and keep the economy going. However, this would keep asset prices elevated and have a minimal impact on rising inflation
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