Fed Meets to Decide Taper While Investors Want Rate-Hiking Guidance
Fed Meets to Decide Taper While Investors Look to Rate-Hiking Guidance
The Fed has a tough job. That is abundantly clear to all that cover financial markets, or work in them in some shape or form. With the Fed concluding its FOMC meeting today, and an official tapering announcement expected, the bigger question is when and how quickly will rate hikes begin? To start, consider that all other developed market central banks have only one mandate to consider: inflation. The Fed has that plus a full, or maximum, employment mandate. It’s that second mandate that adds immeasurable complexity to the Fed’s monetary policy decisions as any rate-hiking decision surely slows economic growth to some extent, and hence job creation, while it also douses to some degree inflationary embers. We dig into more detail below what we expect to hear from the Fed and Fed Chair Jerome Powell later today in that regard.
In our podcast this week we talk with one of our regular guests, Joe Keating, Co-Chief Investment Officer of NBC Securities. Joe discusses his economic outlook for the fourth quarter and also into 2022. Joe has been appearing on our podcasts regularly giving our listeners his insights into both his economic outlook and how that will affect fixed income and equity markets. The iTunes link can be found here and the Spotify here.
Will the Fed Move Towards The Market’s Rate-Hiking Schedule?
The FOMC concludes its two-day meeting today and all expectations are they will unveil their plans for tapering quantitative easing purchases. From previous Fed communications it’s expected they will schedule tapering at $15 billion a month ($10 billion in Treasuries and $5 billion in MBS) to conclude around June 2022. We expect they will include comments that allow some flexibility to that schedule such that if inflation continues to exceed forecasts, they can taper quicker so as to proceed to rate hikes.
The real intrigue of the meeting will come in the press conference when Powell will surely be quizzed about the kick-off and pace of future rate hikes. The market has already advanced to the point of calling for slightly more than two hikes in 2022 beginning in June. Recall, the Fed’s September forecast had them divided 50-50 on a single hike in 2022. Will Powell push back on the market’s expectations, or provide some signal that the Fed is coming around to that expectation as well?
With a new dot plot coming at the December 15 FOMC meeting we expect Powell to deftly deflect such lines of questioning. Also, with tapering taking the expected eight months to conclude, and with the Fed having stated rate hikes will only follow after tapering is concluded, the Fed has plenty of time to assess the economic landscape in 2022 before committing to any type of rate hiking regime.
At the same time, the Fed doesn’t want to hurt its inflation-fighting credibility so the comments won’t all be dovish. He’ll want to convey the Fed is clearly on the inflation case, while also hoping the maximum employment mandate is met by the time tapering is finished giving a green light to rate hikes.
10-Year Inflation Breakeven Rates Starting to Roll Over?
A funny thing happened on the way to higher and higher inflation expectations. The TIPS inflation breakeven rates have just recently started to roll over a bit indicating some softening in the implied inflation forecast from TIPS investors. The graph below tracks the 10-year TIPS Inflation breakeven rate and as we’ve seen most recently it has retreated some in the past week or two. Recall that a TIPS investors gets paid via two sources: a minimal coupon plus a payment tied to the CPI. Higher inflation results in higher compensation.
The breakeven rate is the implied CPI rate that would result in an equivalent yield for the TIPS investor as is received by a traditional 10-year Treasury investor. The breakeven rate declines when the TIPS price declines as more yield is generated from the coupon piece; thus, less is needed from the CPI piece to generate an equivalent yield.
So what is driving the recent decline in TIPS pricing? We can’t say for sure but it could be that the previous run-up in price and increase in breakeven rates to cycle highs got ahead of the market. Or, investors think the Fed will be aggressive in fighting inflation and nip it in the bud with quick rate hikes. Or, it could be TIPS investors think inflationary forces will be more transitory just as the Fed has surmised and that rates will recede again in 2022 and beyond.
Whatever the reason, and it could be a combination of all, the market is at least taking a second look at its inflation outlook and that is giving a pause to both inflation expectations and, as a result, less of a catalyst to push nominal Treasury yields higher.
Agency Indications — FNMA / FHLMC Callable Rates
|Maturity (yrs)||2 Year||3 Year||4 Year||5 Year||10 Year||15 Year|
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