Tapering “may soon be warranted”
In its statement on Wednesday, FOMC provided advance notice that tapering “may soon be warranted”, as widely expected. Chair Powell said that in his view the remaining test of “substantial further progress” in the labor market is “all but met”. He also highlighted that for him there is no need to see a “very strong” September employment report, while he would like to see a “decent” one.
This suggests that the FOMC will likely announce the start of tapering at its November meeting, as we have expected for some time.
FOMC members also provided an updated set of economic projections, including a first look at their expectations for 2024. Based on the new projections, the FOMC's dot plot (see below), suggests FOMC members have pulled forward their expected timeline to hike interest rates from their current near-zero levels, given the recent progress on the economic recovery. The median dots showed 0.5 hikes in 2022, 3 more hikes in 2023, and 3 more hikes in 2024. Previously, the median dot indicated no rate hikes would occur before 2023.
Figure 1. FOMC participants’ assessments of appropriate monetary policy
Source: Projections Materials, Federal Reserve
In terms of pace of tapering, Powell revealed that FOMC participants favor concluding the taper around the middle of 2022. This would imply a tapering pace of $15bn per month. Against that backdrop, rate hikes could come under active discussion as early as September 2022.
Amidst the strong risk sentiment central banks across the world are simultaneously turning less accommodative as inflation risks are growing. This week, Norges Bank hiked rates. The Bank of England opened the door to “modest tightening” as soon as this year. In our view, any change in monetary policy or the inflationary regime will likely have profound implications for the markets.
What is a Federal Reserve dot plot?
Four times a year the policy-setting FOMC publishes a Summary of Economic Projections (SEP). The SEP includes forecasts for where key economic indicators like GDP, inflation, and unemployment will be in coming years. The release also includes the dot plot, which maps out each members’ projections for where interest rates up to three years (and over the longer-run). The dot plot serves as a guide for financial markets.
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