What do the asset managers expect from today’s Fed meeting?

Although the COVID delta variant has raised some concerns recently, the Fed's macroeconomic monitoring shows economic growth materially above potential, an upside surprise in inflation and an improvement in the labour market.

Investor Relations Specialist

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Today it will take place the Fed’s last meeting before the summer break, what should we look out for at today’s Fed’s meeting? We hear from PIMCO, Muzinich & Co, Aberdeen Standard Investments, La Française AM and Generali Investments.

Tiffany Wilding, US Economist at PIMCO

We expect the shockingly firm June CPI inflation report to have little, if any, consequence on the outcome of the July FOMC meeting.  It will only influence a bond tapering announcement in the second half of this year to the extent that longer-term inflation expectations jump higher in response.  We won’t begin to see the impact on the inflation expectations surveys until August.  Therefore, the most likely outcome of the meeting will confirm our December announcement timeline for tapering. 

Overall, there is no question that inflation has made the substantial progress necessary to warrant tapering bond purchases.  Where there is more room for discussion is around what substantial progress means for the labor market.  On this issue, there are two questions that need to be addressed.

First, has maximum employment changed since the pandemic?

And second, how small does the remaining “gap” between actual employment and maximum need to be before tapering is announced?

FOMC members will also need to address a third question, which is even more subjective than assessing substantial further progress: When should the committee provide the so called “advanced notice” that a bond taper announcement is imminent? 

We expect the FOMC to discuss three main issues.  

First will be a menu of options presented by the staff on how to wind down the purchase programs. This will include questions like “will the committee taper MBS first or faster than Treasuries?”.

Second the FOMC will discuss the economic outcomes consistent with substantial progress.

And third, the FOMC will need to decide when and how to provide the “advanced notice” that Powell has promised. Overall, we expect advance notice in September for a December announcement, but can’t rule out a scenario where the FOMC provides advanced notice at this meeting, signaling a September tapering announcement is likely.  Seven FOMC members are currently projecting rate hikes beginning in 2022, and would likely prefer to taper sooner and faster than consensus currently expects. We don’t think Powell is one of them, but we can’t rule out a compromise with these members.

Bottom Line: All of these issues, plus the details of how the FOMC will wind down the purchase programs, will be discussed at the July meeting and we would expect to get more details of those discussions from Powell during the press conference, and the meeting minutes that will be released in August.  Overall, our base case continues to be for a December announcement of tapering both Treasury and MBS purchases, and for the programs to be wound down by August 2022. 

Erick Muller, Head of Product and Investment Strategy, Muzinich & Co.

Although the COVID delta variant has raised some concerns recently, including for the US economy, the macroeconomic monitor for the Fed shows materially above-potential economic growth, upside surprise in inflation and improvement in the labour market. US financial conditions remain quite favourable as the volatility in US equities has been compensated by rapidly falling yields. Primary markets are well open, as well as banks’ balance sheets.

In our opinion, the June meeting was the first announcement that the Federal Open Market Committee (FOMC) will now consider tapering its asset purchase programme of US$120bn per month. The July meeting is expected to discuss the modalities of such tapering. In our opinion Chair Powell will likely favour a simple, clear message, focusing on the top numbers and proportionate a reduction in mortgage-backed securities and Treasuries.

We expect the tapering to be progressive, to limit a potential negative impact on US financial conditions and leaves the market able to adapt smoothly to lower liquidity injections. We would expect the whole process to last several quarters, well into 2022.  While the announcement of the decision to taper may be formally announced publicly, not before the September meeting or end of August at the Jackson Hole symposium, the market is already fully conscious of this coming. The execution of tapering could start by the end of the year or January 2022. The next set of inflation data may influence this timing decision however. 

The attention of market participants on tapering was already caught by June’s FOMC minutes. We do not expect volatility to come from this part of the FOMC discussion at the July meeting. How the forward guidance on rates may evolve is more uncertain and related to inflation. It is clear the Fed has been surprised by the strength of numbers over the past quarter, but was not surprised by the contributors to this surprise. 

We believe the next inflation releases will likely be critical in evaluating the pass-through effect to core contributors to inflation such as non-cyclical components, housing, healthcare and the potential evolution of wages in an improving employment market. Therefore, we do not expect rapid changes in the FOMC narrative on policy rate forward guidance at the July meeting. Although employment market improvement is noticeable, the “inclusive employment” implicit target is far from being reached and this may leave the FOMC forward guidance unchanged from the June meeting. 

Market pricing has now removed most of the rise in yields we have seen since early February and the bar to return to end March levels on long yields seems quite high. We expect US yields to be range bound in the next few weeks, waiting for further information on the nature of inflation over the next couple of months. 

Luke Bartholomew, Senior Monetary Economist at Aberdeen Standard Investments

The market is excited at the prospect of getting some sort of fresh signal from the Fed next week. But that’s unlikely to happen and Powell is more likely to try to play for time.

Much has been made of the signs of discord about policy on the committee. But the core individuals that are the real power brokers of the Fed are all still broadly aligned on the trajectory of interest rates. Moreover, the inevitable spread of the delta variant is certainly a consideration for the Fed, which adds to downside risks.

Last month the Fed surprised many with forecasts implying earlier interest rate increases. They aren’t going to want to pour oil on that fire now. So what we are likely to see is reassuring words about the Fed tracking the delta variant and reaffirming its belief that inflation is transitory. Jackson Hole next month is the earliest that we will see any significant movement on policy.

François Rimeu, Senior Strategist, La Française AM

We do not expect any substantial change from the July FOMC policy statement. On the economic front, we expect the FED to maintain a cautious optimistic tone considering the spread of the delta variant. Employment has strengthened but FED members will need more data before being comfortable tightening financial conditions. We believe Chair Powell will indicate tapering discussions will continue during the summer.

We do not expect major details on the tapering process. The FED may announce a change at Jackson Hole conference (August 26-28) or during the September meeting (21-22) before a formal announcement in December.

We expect Chair Powell to reaffirm that price increases are mainly transitory, but he might emphasize that the Committee could act if higher-than expected inflation was to persist for an extended period.

In summary, we expect the FED to maintain a prudent approach, which will have no significant impact on financial markets.

Thomas Hempell, Head of Macro Analysis, Martin Wolburg, Senior Economist y Paolo Zanghieri Senior Economist, Generali Insurance AM

The reopening of the economy is providing the widely expected boost to the US economy. After a 6.4% ann. increase in Q1, nowcast estimates point to even a 10% expansion in spring. Growth will peak during the summer and will moderate on a fading fiscal stimulus. We still project an above-consensus 7.5% growth for 2021, thanks also to healthy consumption and strengthening capex.

The stark contrast between below-expectations employment growth and record-high job openings point to the presence of bottlenecks in labour supply, such as residual COVID related restrictions, constraints for parents due to school closings and disincentives from unemployment benefits. These factors should disappear over the coming months, leading to faster employment growth.

The reopening of the economy is providing the widely expected boost to the US economy. After a 6.4% ann. increase in Q1, nowcast estimates point to even a 10% expansion in spring. Growth will peak during the summer and will moderate on a fading fiscal stimulus. We still project an above-consensus 7.5% growth for 2021, thanks also to healthy consumption and strengthening capex. The stark contrast between below-expectations employment growth and record-high job openings point to the presence of bottlenecks in labour supply, such as residual COVID related restrictions, constraints for parents due to school closings and disincentives from unemployment benefits. These factors should disappear over the coming months, leading to faster employment growth. 

The spike in inflation triggered by the release of pent up demand has exceeded expectations, with headline and core inflation reaching 5% and 3.8%yoy in May. Inflation is set to moderate during the summer, but the core CPI rate will likely end the year at just below 3%. Elevated inflation is the result of more sticky bottlenecks and the rebalancing of demand from goods to services, which pushes up prices of the latter. Uncertainty on the durability of this dislocation is high. Not surprisingly, households’ inflation expectations are now at the highest level in seven years (according to the University of Michigan survey, Graph 3). Structurally higher inflation expectations alongside a tighter labour market may raise wage pressures and incentivise companies to protect margins, leading to higher actual inflation. 

Against this backdrop, the Fed surprised with a hawkish twist at its June meeting, bringing forward projected rate hikes already to 2023 in its ‘dots’ despite only a very mild (0.1pp) expected overshoot of its preferred 2% core PCE measure by then. This move signalled that the new monetary policy framework is obviously less reflationary than widely perceived so far and seems intended to prevent any de-anchoring of reflation expectations. Our own macro scenario is consistent with a first rate-hike in mid-2023. Shorter term, the Fed will intensify the tapering discussion: we expect an announcement at the September meeting, followed by an implementation at early 2022. Markets expect bond purchases to end in Q4 2022, but the Fed has repeatedly stated that there is not a pre-set schedule and monetary normalisation will depend on realised employment and price outcomes.

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What do the asset managers expect from today’s Fed meeting?