Graeme Jennings | Piscine | Reuters
Federal Reserve officials are likely to voice concerns about the rapidly spreading delta variant of the coronavirus. The market was awaiting news from the Fed on its intention to reduce its bond purchases, the first major step in the easing policy.
“This was supposed to be the meeting where they really focused on the tapering,” said Mark Cabana, head of US short rate strategy at Bank of America. “We think the market is going to end up hearing Powell ringing from neutral to accommodating, at least from a rate market perspective, primarily because he’s going to keep talking about the downside risks of Covid. “
The Fed issues a statement Wednesday at 2 p.m. ET, following its two-day meeting. President Jerome Powell addresses the media at 2:30 p.m.
Fed watchers expect officials to discuss reducing their minimum monthly purchases of $ 120 billion of treasury and mortgage-backed securities. They also expect it to start rolling out at the end of this year or early next year.
“In the FOMC statement, they talk about how the trajectory of the economy depends on the trajectory of Covid,” Cabana said. “Because of this, they will naturally seem cautious. They will talk about reduction, but that will seem like a formality given that they will have to note that there are increasing downside risks. “
The moment of reduction
But Cabana expects the Fed to start declining gradually early next year, evenly reducing mortgage and treasury bill purchases over a 10-month period.
“I think the resurgence of Covid pushes back the idea that they’re going to start declining in the fourth quarter,” he said. “I think we can all agree if we live with Covid longer than we thought, inflation potentially becomes a lot less of a concern as demand will decrease. In this context, we think there is really one thing… that matters in the world, and that is the path of this virus. “
Cabana said he expects the Fed to signal at its September meeting that it will slow bond buying. He also expects from Powell that the purchases are not necessarily mechanical and that the Fed could slow them down or speed them up if it wishes.
The Fed is generally expected to take up to a year to stop buying, and at this point it could be open to an interest rate hike. In its forecast, it forecasts two interest rate hikes in 2023.
“He’s going to have to admit that the delta variant makes the uncertainty about the outlook much higher. He has to be very careful with the words he uses, ”said Diane Swonk, chief economist at Grant Thornton. Economists said the delta variant is not yet showing up in economic data, but it could.
“The problem is that it is now more difficult to solve these supply chain problems,” she said. “It can also dampen demand. … I wouldn’t be surprised to see people cancel their entry into restaurants. “
The Centers for Disease Control and Prevention was expected to recommend Tuesday that even vaccinated people should wear masks indoors in areas with high Covid transmission rates. The real risk to the economy is that the spread variant will slow reopening or force schools to stay closed.
Swonk said the Fed is talking about a shrinkage, and some members are pushing it as soon as possible. But if the Covid variant starts to impact the economy, it could affect the discussions.
“It could change their taper schedule. I don’t think they want to change anything right now because they want to see what happens first, ”she said. “The most important thing about tapering is if the financial markets can continue to function while they are going through this? It will all depend on our ability to follow a British model and get to the point where it is more manageable again. “
Jim Caron, head of global macro strategies at Morgan Stanley Investment Management, said he expected Powell to ring as much as he did during his recent testimony to Congress on the economy.
“As he said in his biannual testimony, ‘Things are looking up, but we may still be a long way from making substantial further progress,” said Caron. “I think they’re going to say they talked about the cut, but he will come back without any decision having been made yet. “