Image Credit: Federal Reserve (Flickr)

Tapering Begins, Low Rates Will Persist, Here’s Why

The much-anticipated Fed statement after its two-day November meeting was released just after 2 o’clock, and there were some surprises for some but it met expectations for most Fed watchers. Its policy stance is still quite dovish despite recent inflation numbers.  The statement, which summarizes the Fed’s intentions, laid out plans for reduced bond and mortgage purchases while at the same time mentioning the target for the overnight bank lending, Fed funds rate.

The Fed confirmed that it would begin tapering by reducing its monthly bond purchases. It has been supporting the interest rate market and adding money to the system through $120 billion in bond purchases each month. The purchases include U.S. Treasury debt and mortgage-backed securities. This monetary policy shift will begin this month. The Fed announced it would do this by reducing monthly purchases by $10 billion for bonds and $5 billion monthly for mortgage-backed securities. The statement includes language that says that although this is the plan they deem prudent, they may change it if conditions change. 

What economists listened for in the statement was the word “transitory” as it relates to inflation. Recent data shows inflation is running higher than we have seen in well over a decade and hasn’t shown any clear sign of declining or being short-lived. In their statement, Fed officials acknowledged that inflation may be above their 2% target longer than originally thought, but they attribute the recent price increases to “supply and demand imbalance related to the pandemic and reopening of the economy.”

Expectations that the Fed would have to move
early and aggressively have risen recently, they had originally indicated that rates would remain near current levels until 2023 and purchases would continue into 2023. That the Fed is continuing to call inflation “transitory” suggests that the it will keep a steady hand and slowly undo the extraordinarily high level of accommodation in the banking system.

Take-Away

The Fed has begun taking steps to reduce the historically high levels of stimulus within the banking system and economy. They are moving slowly as it is recognized that the economy is still quite fragile. The wild card is still inflation, price increases have already been a little stickier than the Fed expected. Should this continue, the Fed could accelerate their plans, should the economy show weakness, they left open the possibility of adjusting their tapering pace.

Suggested Reading:

The High Points of Fed Chairman Powell’s Presentation are Worth Understanding

Founder of WallStreetBets has a New Idea for CopyCat Investors

Yield Curve Control, Stock Prices, and Trust (July 2020)

Federal Reserve Board Chairman Powell’s Resolve on Display (June 2020)

Sources:

https://www.federalreserve.gov/newsevents/pressreleases/monetary20211103a.htm

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