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The big brains at the Fed are announcing their decision tomorrow at 18:00 UK time.
Yeah, Central Bank meetings are pretty boring, but it's the Fed and it can impact every market so we kinda have to pay attention...
What do we 'know' so far?
The QE taper announcement is 99% nailed on. Most analysts expect an overall reduction of $15bn per month. Purchases would end by June '22.
Something like this 👇
But they're also under pressure to respond more directly to inflation.
Powell and other members have made it clear that while the inflation goal has been met, the employment side of the equation is still lagging.
Their 'full employment' goal sets a higher bar for rate hikes, even as the exact measures of 'full' are especially tricky to define right now...
Remember, the whole premise of the new FAIT framework is that underlying wage pressures driven by a strong jobs market are necessary for overall demand to be sustained.
Without this, inflation will slow below the 2% (on average) target again...
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Fed-Watcher Tim Duy makes the case that the central bank will reinforce the framework at this meeting...
He's probably right.
Although, will they necessarily put the focus on it right now?
Perhaps it's enough to say 'if inflationary pressures persist AND we continue to make substantial further progress towards our full employment goals we have the tools to bring inflation down' and let the market interpret...
Then there's the market hike expectations. The swaps market is pricing three hikes in 2022!
Surely Powell will take the opportunity to push back against that in the press conference.
Especially as inflation expectations seem to be rolling over lately...
We highlighted earlier today that some of those inflationary pressures in commodities are starting to ease, alongside overall demand 👇
David Belle
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It's a very mixed and uncertain picture right now.
Once again, the key to a successful meeting will be the messaging and forward guidance. Powell has done a pretty good job of staying consistent on this.
What's the right mix?
A Fed that will look to taper at the $15bn pace while
- allowing time for employment to further improve,
- reaffirming the concern/ability to respond to inflation sooner if it were to prove less transitory
Would be a winning combination...
On the other hand, if they are so worried about inflation that they're talking about potentially increasing the pace of tapering next year so they can move quickly on to hikes...
Well, that probably wouldn't be great for riskier assets.
And there's one other thing to consider...
What if rate hikes are actually inflationary?
Don't worry, I'm not going full Erdogan and reinventing monetary policy!
It's all about financial 'plumbing'.
Basically, how money moves through the different pipes in the system.
Once upon a time, banks were heavily influenced by the yield curve.
Banks would borrow at the green line (currently 0.1%), and lend to the public at the blue line (currently 3.3%) pocketing the difference. 👇
In simple terms, the difference between short term rates and long term rates was their profit.
What's changed?
Banks now have a superabundance of retail deposits, which equals loads of 'free' money available for them to lend out when they see the right opportunities. 👇
That creates a big incentive for banks to lend more if rates increase...
If a central bank hikes rates, the theory is that it would limit credit creation and slow the economic expansion.
However, in this 'new normal', there's potential that rate hikes could actually have the opposite effect...
If you want to dive deeper the screenshots are taken from this excellent work by Joseph Wang. 👇
Joseph Wang
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David Belle
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