by Blaine Dickason
Senior Vice President, Trading and Fixed Income Portfolio Management
A year ago, Federal Reserve Chair Jerome Powell famously said, “We’re not even thinking about thinking about raising rates.” At this week’s Federal Open Market Committee (FOMC) meeting the Fed took its first tangible steps to lay the groundwork for a gradual removal of the stimulus measures enacted last year. In a sign that the Fed was both bullish on the economy and cognizant of concerns of runaway inflation, they also used this meeting to signal that future interest rate hikes might occur sooner than previously projected. After providing significant stimulus to the economy this past year, it is clear the Fed will now be spending its summer “talking about talking about” its exit strategy.
“The Federal Reserve … is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”
- William McChesney Martin Jr., Fed Chair 1951-1970
This famous ‘punch bowl’ quote is especially fitting at this point in the market cycle. The economy withstood a tremendous exogenous shock from the pandemic and policy makers quickly implemented tools to keep an economic crisis from becoming a financial crisis. With substantial gains in both the economic and health data since the depths of last year, it makes sense that the existing levels of stimulus no longer are necessary. Unfortunately, the Federal Reserve does not have a great track record of executing these transitions and, historically, heightened market volatility has accompanied these delicate policy shifts.
It has been widely known that the $80 billion of Treasuries and $40 billion of mortgages purchased by the Fed each month would end at some point. The only historic parallel investors could refer to was 2013 when a similar plan was rather indelicately announced by then Chair Ben Bernanke, resulting in rising yields and a short but sudden equity selloff. While intentions only get you so far, the current Fed is keenly aware of the poor communication and execution during 2013’s ‘Taper Tantrum’ and, to date, has taken great pains to communicate their goals for the current taper to be (1) orderly, (2) methodical and (3) transparent. Based on comments from this week’s FOMC meeting, the likely scenario is that the reduction in purchases will occur throughout 2022, clearing the way for a possible liftoff from near-zero policy rates the following year.
Inflation expectations have been building throughout this year as a rapidly reopening economy ran headlong into production and supply-chain bottlenecks. The Fed’s recent average inflation target of 2 percent further elicited fears that periods of higher inflation can not be brought back to heel. The accelerated path for rate hikes shared from this week’s FOMC meeting has so far addressed these concerns and materially has lowered the odds of an inflation scare. While the Federal Reserve still asserts recent inflation will be transitory, the shift in the median interest rate projection from zero up to two hikes in 2023 indicates they are fully prepared to address elevated prices if those inflation pressures are higher or longer lasting than currently estimated.
Week in Review and Our Takeaways:
Weekly initial jobless claims reported yesterday rose for the first time in seven weeks to 412,000 from 376,000 last week. The four-week moving average continued to trend lower
Lumber prices have declined over 45 percent since their recent peak on May 7th, 2021 (July 2021 futures contract)