Here Comes the Fed's Accelerated Taper

By: Edward Jones
DEWITT, Mich. - Dec. 14, 2021 - PRLog -- U.S. equity markets rebounded this week, after two weeks of losses, as investors were able to climb two key walls of worry: the path of the Federal Reserve and the path of the COVID-19 virus.

We will likely get more clarity on both issues in the week(s) ahead, with investors digesting both the December FOMC meeting next week as well as incoming data around the omicron variant, which thus far appears less severe than originally expected

Jerome Powell's Big Pivot

In the midst of the omicron scare last week, Fed Chair Jerome Powell surprised markets with a somewhat hawkish pivot in a couple of notable areas. First, he suggested that the word "transitory" be retired when discussing inflation – implicitly acknowledging that inflationary pressures have been more persistent than the Fed had expected.

The second pivot from Chair Powell came around the path of the Fed's taper. Powell noted that accelerating the path of the Fed's balance-sheet tapering "by a few months" could make sense, as it would allow some flexibility around when the FOMC could start raising rates, particularly if inflation continues to remain stubbornly high. This notion was touted by several Fed governors last week as well.

Friday's inflation reading may have sealed the deal

Indeed, on Friday we saw that CPI inflation remained elevated through November. Headline inflation figures came in at 6.8%, the highest levels since 1982, while core inflation was 4.9% year-over-year, in line with expectations but also elevated. While inflation remains high, keep in mind that these are backward-looking readings; this CPI figure, for example, does not account fully for the recent drop in energy prices, and we could see moderating prices in the months ahead.

Nonetheless, the inflation reading likely underscores the need for the Fed to take action and accelerating the taper process is a concrete step in battling inflation. This also comes as the labor market continues to show signs of improvement, with the unemployment rate now at 4.2%, well below the pandemic peak of 14.8%. So, between the Fed's dual mandates – inflation and labor – the Fed may be shifting its focus to battling inflationary pressures over improvements in the labor market, at least for now.

What do we expect the Fed to do next week?

We see three key outcomes from the December FOMC meeting:We expect the FOMC to announce an accelerated balance-sheet tapering process at next week's meeting. The pace of tapering will likely increase from $15 billion per month currently, to perhaps close to $30 billion per month. This would allow the Fed to wind down its tapering process by the first quarter of 2022, making room for the start of its rate-hiking cycle, if needed.

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