Fed starts to taper asset purchases

Edward Bell - Senior Director, Market Economics
Published Date: 04 November 2021

 

The Federal Reserve announced it would start tapering its asset purchases at the November FOMC which concluded overnight, drawing down the pace of UST and MBS buying by USD 10bn and USD 5bn per month for at least November and December. The tapering announcement came in line with our own and market expectations but the Fed hasn’t given a set path for the timeline of tapering asset purchases, suggesting they could speed up or slow down as conditions warrant.

Language around inflation remained dovish and still more or less in line with the view that the price increases affecting the US economy are transitory. In his press conference after the FOMC, Fed chair Jerome Powell said that the Fed can “be patient” but “will not hesitate” if inflation gets to levels that need a response. Powell acknowledged the “high inflation” but that it needed to “balance with what’s going on in the employment market.” All told, the FOMC looks to us like a dovish tapering, not a panic to catch up with inflation at +5% in the US at the moment.

Market looking for rate hikes next year

Source: Bloomberg, Emirates NBD Research. Note: eurodollar futures.

Markets took the FOMC largely in their stride as the tapering announcement was widely expected. Yields on the 2yr UST rose a bit less than 2bps to around 0.46% while the 10yr gained 5bps to move back above 1.60%. Eurodollar futures fell slightly although the overall market expectation—not our assessment—for two hikes in 2022 remains intact. The relatively modest response suggests, to us at least, that the Fed hasn’t lost control of the market and there is still belief that it will be able to dampen down inflation.

The FOMC appears to be tilting in favour of its mandate to secure full employment rather than stable prices at present. Chair Powell did seem to accept that the US economy could achieve maximum employment by the second half of 2022 if the pace of labour market gains continued with where it has been over the last year. That could open up the way to an earlier start to rate hikes than our current expectations of the start of 2023 but we still believe the Fed will choose to keep conditions for employment highly accommodative to pull as many people back into the labour force as possible. The labour market is improving in the US but prime age participation still remains well off pre-pandemic levels and as we noted in our podcast “Discussing labour market frictions”, there are many outside forces keeping workers from coming back into the labour force.

Labour force participation rate: prime age workers

Source: Bloomberg, Emirates NBD Research.