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Talking About Tapering, In December

After many months of “telegraphing” the first pullback of accommodative policy instituted in the wake of the Covid financial meltdown of March/April 2020, Fed Chair Powell indicated that we should expect a formal announcement “soon” (most likely at the next meeting in early November) and tapering to begin in December. Keep in mind that if the Fed lowers purchases by $10-$15 billion per month, there will still be over $500 billion of bonds purchased during a 6-9 month process. The Fed statement today indicated that, “If progress continues broadly as expected, a moderation in the pace of asset purchases may soon be warranted”. Significantly, the consensus amongst Fed members was unanimous. Inflation continues to be the unknown factor, transitory or sticky? The Fed core inflation projections increased (3.7% this year vs 3.0% months ago, 2.3% in 2022, 2.2% in 2023). So inflation may be a little stickier than estimated early in the summer, with future years at just over the Fed’s target of 2.0%. Powell indicated that economic growth is progressing (although the Delta variant spikes have dented earlier optimism) and conditions warrant tapering. He also said that the economic growth threshold for “liftoff” (raising rates from 0%) is nowhere near being met at this time. However, 9 of the 18 members now predict a rate increase in 2022, with 3 members predicting 2 increases. Projections for 2024 show an expected “neutral rate” of 1.75% or 7 increases in the next 3 years (neutral rate is the predicted “Goldilocks” rate, neither stimulative nor slowing). Markets seem very receptive to the Fed’s plan, no “tantrum” today as the 10 year T yield actually dropped about 3 bps this afternoon, closing at 1.30%. The big question is how will treasury markets react to the expected announcement at the next meeting? Meanwhile in Washington, markets are watching the Congressional debate on the upcoming debt ceiling with trepidation. The US has never breached their obligations (treasury bonds) which are an underpinning of the entire financial system Moody’s has indicated that a default of the US treasury obligations could cost $15 trillion in stock losses and 6 million jobs would be erased. Many expect a solution “just in time”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners