Thread the needle.
That’s Jerome Powell’s task this week. In his post-FOMC press conference, Powell will need to gently reiterate the Fed’s intention to begin paring monthly bond-buying while reemphasizing that the threshold for raising rates is qualitatively (and, one assumes, quantitatively) different from that associated with the taper.
It shouldn’t be too difficult a task, but I doubt he’s looking forward to it. Powell’s Jackson Hole remarks echoed (in some cases almost verbatim) the July Fed minutes, both in reiterating that a taper unveil is likely “this year” and in seeking to delink liftoff from the taper timeline. “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” he said.
So, the message is thoroughly socialized. When it comes to the data, the deceleration in core CPI as well as a subpar August jobs report are plausible deniability for any dovish lean. Even the solid read on August retail sales came with a sobering caveat: Spending at restaurants and bars flatlined, consistent with the 42,000 jobs the sector lost last month.
One challenge for Powell, though, is that this is an SEP meeting, and any shift in the dots or projections will need to be squared with the notion that the Fed is nowhere near hiking rates and that the taper timeline (see two plausible scenarios in the figure, below) doesn’t have ramifications for liftoff timing.
The idea that the taper schedule and liftoff are totally delinked isn’t completely true. Ideally, you want to avoid any scenario where you’d be compelled to hike rates while the taper is ongoing. It’s not so much that such a conjuncture would amount to double barreled tightening that’s the problem. Rather, the issue is that just about the only situation where that outcome is conceivable is one in which a dramatic surge in inflation necessitates emergency rate hikes. Absent that, hikes are off the table until the taper is completed. So, in that sense anyway, the two are linked.
An actual unveil of a taper timeline this week would constitute a hawkish surprise. Let’s be clear about that. I think it’s fair to say the chances of an unveil Wednesday are basically zero. A formal announcement (complete with a schedule) would cause all manner of fireworks. Officials surely know that.
I’m including the YoY visual of the Fed’s balance sheet and the S&P (below) because I have to. It’s a slightly more nuanced version of the ubiquitous stocks versus total balance sheet chart.
“The first order post-Fed trade will be the response to ‘delayed’ taper – all else being equal, this will translate into a bear steepener, particularly if the price action following the August NFP print is any guide,” BMO’s Ian Lyngen and Ben Jeffery said late last week.
If that sounds counterintuitive, remember that the whole point of QE is to stimulate. Yes, ultra-accommodative policy ultimately exerts downward pressure on yields, but wider breakevens are a referendum on the Fed’s success. Or at least they were, until they started to become a source of consternation as realized inflation quickened.
Beyond that, though, Lyngen reminded market participants that “recent moves in US rates reinforce the notion that investors have long-since moved on from trading any bond bearish implications from the wind down of QE and instead have simultaneously focused on the ramifications of less policy stimulus and progress toward the first hike of the cycle.” So, a delayed taper unveil could anchor five-year yields while (and I’m quoting Lyngen again here) “giving the long-end room to incorporate the unrequited reflation that’s been so thematic in 2021.”
“We don’t expect a tapering announcement from the upcoming meeting, but officials will likely signal that the planning process for tapering is well under way and that tapering is likely to be announced soon,” TD said. “We expect the chairman to emphasize once again that the criteria for tightening via rate hikes are very different from the criteria for tapering,” the bank’s Jim O’Sullivan wrote, adding that although TD doesn’t “expect the dot plot projections to suggest any new urgency for hikes… given dot-plot arithmetic, any changes to the 2022 and 2023 medians are more likely to be up than down, and the newly added 2024 projections will almost certainly show further tightening.”
For their part, Morgan Stanley expects adjustments to the statement language “to indicate another step toward tapering – ‘if the economy evolves broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.'”
“During the press conference, Powell is likely to remind everyone that tapering could be constructed similarly to last cycle, with the flexibility to speed up or slow down/stop should conditions warrant,” the bank’s Ellen Zentner said, adding that Morgan’s base case is still for a taper announcement at the December meeting of $10 billion in USTs and $5 billion in MBS per meeting, starting in January.”
As for the dots, Zentner is looking for an unchanged median in 2022, three hikes in 2023, and three additional rate hikes to end 2024 at 1.625%. “Powell will have ample opportunity to de-emphasize the importance of the dots as a policy signal,” she added.
Note that Powell has a penchant for essentially pleading with the media to stop obsessing over the dots and/or deliberately misinterpreting them, given that such intentional misrepresentations could affect public perception of the policy stance. The media never listens, not because reporters don’t understand, but rather because their editors don’t care.
Of course, if the Fed is that concerned about such things, they could simply stop releasing the dots in the first place, given the inherent absurdity of asking the public to pay no attention to projections for the price of money when those projections emanate from the people who set that price.
“At the July meeting, Powell said that the Committee would give advance notice before any taper announcement. We think that this time around, he will be explicit communicating that they are now giving such advance notice,” UBS said, in their own preview. “He will probably be asked if the taper announcement will be made in November [and] we expect he will be noncommittal on this and will mention that there is still some discussion to be had on pace, composition and other details.”
This comes as the White House (read: Janet Yellen) considers whether to reappoint Powell. Some high profile Democrats aren’t particularly enamored with Jay for a variety of reasons, but he’s nowhere near the top of the list when it comes to people Progressives are displeased with.
Finally, I suppose it’s obligatory that I allude to some kind of undesirable outcome for risk assets once the liquidity spigot is dialed back. This is so repetitive after a dozen years that it’s become exhausting, but I try to remind myself that not everyone has been immersed in the debate for more than a decade, so “reminders” aren’t as superfluous for the general investing public as they are for the “pros” (whatever that even means these days).
“The economy and earnings used to be the most critical drivers of market returns, but monetary policy has eked out an increasingly important role following the Global Financial Crisis,” BofA’s Savita Subramanian wrote earlier this month, noting that “earnings used to explain nearly 50% of market returns pre-GFC versus just 17% post-GFC.”
Changes in the Fed balance sheet explained most of the difference.
Subramanian looked at the impact of central bank liquidity on the S&P “assuming market returns are driven by earnings and factors other than earnings.”
Her regression analysis “suggests changes in the Fed balance sheet have explained over 50% of the non-earnings portion of changes in market cap for [stocks] since the financial crisis.”
Read more: No Way Out Of This Rabbit Hole