The Fed will likely open a ‘conical’ door for buying bonds, but will hedge on the outlook

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WASHINGTON (Reuters) – The Federal Reserve is expected to lead the way on Wednesday for cuts to its monthly asset purchases later this year and show in updated projections whether higher-than-expected inflation or a resurgence of the coronavirus pandemic weighs more on the economic outlook.

FILE PHOTO: Federal Reserve Chairman Jerome Powell testifies during a hearing of the United States House Oversight and Reform Subcommittee on the coronavirus crisis, on Capitol Hill in Washington, US United, June 22, 2021. Graeme Jennings / Pool via REUTERS / File Photo

Fed policymakers, who are wrapping up their final two-day meeting, have been faced with a set of conflicting developments since late July – signs of a downturn in the services sector, a COVID-19 surge that has eclipsed that of last summer and weak employment growth in August, all accompanied by still high inflation – and have been at odds with each other over how to react.

Officials have mostly said the economic recovery will continue and allow the U.S. central bank to continue its plans to cut its $ 120 billion in monthly purchases of treasury bills and mortgage-backed securities. by the end of 2021, and reduce them completely in the first half of next year.

But forecasters and outside analysts expect the Fed to hedge exactly when the “taper” might start, and tie it to a rebound in job growth after August’s surprisingly lukewarm report, when only 235,000 jobs were created.

The Fed is due to release its latest policy statement and economic projections at 2:00 p.m. EDT (6:00 p.m. GMT), with Fed Chairman Jerome Powell holding a press conference half an hour later to discuss the outcome.

The statement is likely to recognize that the economy has taken one step closer to the “substantial further progress” the Fed has said it wants to see in the labor market before cutting its bond purchases, said economists at Jefferies Aneta Markowska and Thomas Simons in an analysis. While employment growth in August was disappointing, the non-farm payroll in the United States increased by just over a million in July and has increased by an average of 716,000 since May.

Nonetheless, high-frequency data and other employment indicators have hinted that future job gains may also disappoint, and analysts at Jefferies have said the first real reduction in asset purchases will likely be ” conditional on a solid job gain in September “.

The U.S. job market remains about 5.3 million jobs below what it was before the pandemic.

More than 60% of economists who responded to a Reuters poll said they expected the reduction in bond purchases to begin in December.

Fed officials, however, may decide they need more time to assess the risk of a handful of evolving issues before deciding to go ahead with the reduction in the purchase program. ‘obligations. Financial markets were rocked last week by concerns about the spillover effects of the potential collapse of a major Chinese real estate developer, China Evergrande Group, and the S&P 500 index started the week with its biggest loss daily in four months.

Meanwhile, U.S. lawmakers don’t seem any closer to resolving a partisan deadlock in Congress over lifting the federal debt ceiling, with the potential for a partial federal government shutdown increasing day by day.

INFLATION WATCH

When the decline in bond purchases comes, it will mark the start of a shift from the measures put in place in March 2020 to help the economy weather the pandemic, and towards more normal monetary policies that will eventually include higher interest rates.

Powell, who will likely learn before the Fed policy meeting on Nov. 2-3 if President Joe Biden wants to nominate him for a second term as central bank head, stressed in several high-profile speeches, including in Kansas City. . The Fed research conference last month that the possible start of the decline in bond purchases is unrelated to the interest rate debate. This is a point he is likely to reiterate on Wednesday.

However, the new economic and interest rate projections from policymakers will give some idea of ​​how quickly rate hikes can follow the decline, and particularly whether a surge in high inflation has caused officials to forecast an initial increase. for the next year.

The Fed’s preferred inflation measure in July was around 4.2% on an annualized basis. This is double the central bank’s 2% target and enough in the minds of some officials to deliver on the central bank’s new pledge to let inflation slightly exceed that target for a while to keep it going. ensure that it is achieved on average, a precursor to an increase in rates.

Leaning the other way: the wave of COVID-19 infections driven by the Delta variant of the coronavirus.

Since June, when the Fed noted the positive impact of COVID-19 vaccinations and said the economy’s performance appeared to be parting with the pandemic, the seven-day average of new daily infections had quintupled to 66 000 by the central bank on July 27. -28 meeting. Since then it has roughly doubled.

Some measures of service activity have declined, prompting forecasters to downgrade their outlook for economic growth this year.

The Fed may well follow suit.

Reporting by Howard Schneider; Editing by Paul Simao


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