The Talk About Talking About Tapering

During yesterday’s Federal Open Market Committee, the Federal Reserve began to lay the groundwork for a taper beginning.

While the benchmark interest rate was unchanged at close to zero, the central bank officials signaled the possibility of two rate hikes in 2023 (earlier than previously discussed) and increased inflation expectations to 3.4% (a full percentage point higher than last meeting in March).

As news of this shift in stance came out, bond yields jumped, and stocks turned sharply lower. The Dow Jones Industrial fell as much as 382 points, but major equity benchmarks traded off their lows after Fed chairman Jay Powell indicated at the press conference that the dot plot projections should be taken with a “big grain of salt” and that liftoff is “well into the future”.

No mention of a reduction of $120B per month bond buying helped allay concerns, as well as the statement that the Federal Reserve will very carefully communicate its intentions to begin the tapering. In Powell’ s own words – this meeting can be viewed as the meeting where the committee started “talking about talking about” increasing rates. Powell added that the current conditions are far from where the economy would need to be for the central bank to hike rates. Fed officials mentioned wanting the economy to get closer to “maximum employment” and sustained 2% inflation.

Notably, on more than one occasion, Chairman Jerome Powell raised the possibility of inflation running hotter than expected, stressing that “higher and more persistent “inflation would push the Fed to adjust its stance sooner than expected. “We would not hesitate to use our tools to address that.”

The Federal reserve indicated that they continue to monitor the economic data and will make data dependent decisions on its asset purchasing program, but that no decisions have been made yet. Inflation readings over the next few months will be key to watch and should help gauge the Fed’s next move. But as Fed chairman Powell reiterated, the Fed plans to give markets plenty of advance notice before it begins to take away the punchbowl, but then again the markets may choose not to wait for a Fed’s “heads up”.

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