The Fed: One Step Closer to Tapering

The markets were not in for a surprise. The Federal Open Market Committee Meeting (FOMC) left the base rate unchanged, at 0% to 0.25%, leaving room for a slightly extended period of accommodative policy. But how long would this be? The language of the Fed statement is more reflective of the
thinking of the majority at the FOMC meeting. The language and the tone are more hawkish this time, and with each meeting it has been turning more and more hawkish. This indicates the impending change in the policy in the not-so-distant future. The current developments are quite in line with what
many economists and analysts expected.

The latest FOMC statement echoes the views expressed by the Fed Chair in his recent Jackson Hole speech. Jerome Powell in his speech had mentioned, “My view is that the substantial further progress test has been met for inflation,” and that “There has also been clear progress toward maximum
employment.” In this context the FOMC statement indicates that, “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.”

The markets have been looking at all the communications coming from the Fed for any indications towards the timeline of liquidity withdrawal and rate hikes. The effects of “taper tantrums” of 2013 have led to market participants expecting that the Fed would be a bit more transparent with its communication as to when it intends to start normalising the bond purchase programme.

While the exact timing may be anybody’s guess, if the strength in growth numbers shows some consistency coupled with robust employment numbers, the bond buying may get truncated as soon as in the first quarter of calendar year 2022, with an emphatic indication coming from the November meeting of the FOMC. The reduction in bond buying would have an impact on system wide liquidity, and may result in a negative reaction, but the liquidity withdrawal alone may not have much bearing on asset markets. The critical factor is the change in stance and subsequently the market expectations aligning towards the follow-up policy action, a rate hike.
As the Fed projections of key economic variables have evolved in line with the incoming data, the expectations of a policy action, in terms of rate hike, too have moved in tandem. The median GDP forecast for 2021 has been lowered to 5.9% in Sep’21 as compared to 7% growth projected in Jun’21. The
GDP growth forecast for subsequent years, 2022 and 2023, has seen some marginal improvement. The unemployment rate is now projected to be slightly higher at 4.8% for 2021 as compared to 4.5% as per June projections. The personal consumption expenditure (PCE) based inflation is now seen at 4.2% for 2021 as against the projection of 3.4% made in June



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