Fed chief Jerome Powell has said the central bank will begin warning investors of a move to begin tapering its crisis program of bond purchases 'well in advance' of an actual reduction.
Sarah Silbiger/Getty ImagesFederal Reserve Chairman Jerome Powell said last week that the central bank still isn’t ready to discuss reducing the pace of bonds purchased as part of a program to keep interest rates low. The question for investors: When will that time arrive?
Fed officials, who have said the economy needs to make “substantial further progress” toward inflation and employment goals before beginning to tighten policy, have also assured investors they will start signaling a move to taper bond purchases “well in advance” of the decision. That means that when the Fed starts to talk about tapering bond purchases, it in effect starts the clock for the actual reduction of bond purchases, assuming the economic data cooperate.
Wall Street strategists say it should take about a year to wind down the $120 billion in monthly bond purchases once the process begins, and they don’t expect the Fed to start raising interest rates from near zero until that process is finished. So if investors can sort out when the central bank plans to start talking about tapering its bond purchases, they can build an imprecise timeline for interest-rate increases and shape their investment portfolios around their expectations for Fed policy.
That timeline could affect rate-sensitive stocks and the level of Treasury yields of all maturities: If tapering comes sooner than expected, or the central bank signals it will wind down its bond buying at a quicker pace than expected, yields will likely rise. If their communications hint at a slower move, that would imply lower yields.
Traders have been gaming out these scenarios all year, of course. Financial markets have been pricing the Fed’s next rate increase in early 2023, according to derivatives prices. The process of pricing that expectation into markets wasn’t exactly smooth, however, so the Fed’s first step towards withdrawing support from markets could be bumpy as well.
Many market watchers expect the conversation to start some time this year, but Wall Street doesn’t seem to have a clear consensus on what exact month those discussions will start.
The Case for June
Aneta Markowska and Thomas Simons, money-market strategists at Jefferies, say the Fed could decide to start discussing tapering plans in June. They base their view on their forecasts for an adjusted unemployment rate cited by Powell, which includes misclassified workers and labor-force dropouts in the ranks of the unemployed. They estimate that 2.1 million jobs could be created in April alone—heightening focus on this Friday’s report. That means the adjusted unemployment rate could easily fall to or below 7.5% by the Fed’s June 15-16 meeting, and, in their view, allow officials to start talking about stepping back the pace of bond purchases.
“While [that progress] may not qualify as ‘substantial,’ it should be enough to at least start talking about talking about tapering. After all, Powell has promised to start communicating the shift well in advance,” they wrote in an April 28 note.
The Case for August
Deutsche Bank says that the Federal Reserve’s annual conference in Jackson Hole, Wyo., in August could be a better bet, as Powell and other top Fed officials have been cautious about spooking markets with their comments.
“While some Fed officials may want to more openly discuss tapering by the June FOMC meeting, it is likely to take Fed leadership until later in the summer to reach that point. We continue to see the Jackson Hole conference as a potential event to more formally flesh out the case for tapering, with an official announcement coming at the December FOMC meeting,” the bank’s economists wrote in an April 28 note.
September or November?
Other banks have published forecasts for the actual timing of an announcement along with the timing for the advance warning. Barclays estimates that the central bank will in November announce formal plans to reduce its bond purchases, and start the tapering process in January 2022. TD Securities forecasts that the Fed will announce its decision to taper bond purchases in March 2022, and that officials will start discussing the move publicly in September of this year.
To be sure, all of these scenarios depend on continued strength in economic data and the U.S. recovery from Covid-19.
But few expect the recovery to slow down soon. And if economic data beat expectations, market volatility could pick up as investors and traders retool their Fed forecasts.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com
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