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U.S. Federal Reserve: Let the tapering begin

Key messages

  • The target for the federal funds rate remains at 0-to-0.25%.
  • The Fed will begin to reduce asset purchases this month.
  • Inflation remains elevated but is still expected to reduce as supply constraints ease.

In this week’s announcement, the U.S. Federal Open Market Committee (FOMC) unanimously decided to hold the target for the federal funds rate at 0-to-0.25%. It added that it expects to maintain this target range until its maximum employment and long-term inflation goals are sustainably met.

In-line with expectations, the U.S. Federal Reserve (Fed) announced it will begin reducing the monthly pace of asset purchases by US$10 billion for Treasury securities and US$5 billion for agency mortgage-backed securities.

Stop, taper time

Given the substantial progress the U.S. economy has made since the beginning of the year, the Fed has decided to taper its quantitative easing program.

Despite the planned reductions, the FOMC will still increase its holdings of Treasury securities and agency mortgage-backed securities by at least US$70 billion and US$35 billion this month. For December, it expects to purchase at least US$60 billion and US$30 billion respectively.

Further outlining its plans, the Fed stated that it expects similar reductions in the pace of purchases each month after that. However, it is prepared to adjust the pace if the outlook changes. Pandemic-related risks remain.

It is expected that tapering should finish by mid-2022 (as previously discussed by officials), making way for one-to-two potential rate hikes in the latter-half of next year. Nonetheless, depending on how “transitory” inflation ends up being, we wouldn’t be surprised to see no hikes in 2022.

Supply and demand imbalances driving short-term inflation

Indicators of economic activity and employment have continued to strengthen given vaccination progress and strong policy support.

The Fed acknowledged that inflation remains elevated but reiterated that the supply and demand imbalances pushing prices higher now are transitory – that inflation is expected to normalize towards its 2% target as supply constraints ease.

Overall financial conditions remain accommodative

Markets welcomed the widely expected announcement – we saw equity markets and U.S. bond yields move higher and the U.S. dollar trade lower relative to the Canadian dollar following the Fed’s statement.

As for our positioning, we remain overweight equities relative to fixed income with a preference for developed markets (particularly the U.S.). Within our fixed income positioning, we remain short interest rate risk and have positioned for a flattening yield curve. For more information, please contact your MD Advisor*.

The Fed’s next interest rate announcement is scheduled for December 15th and will be accompanied by the latest Summary of Economic Projections.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Richard Schmidt, CFA, is an Associate Portfolio Manager with the Multi-Asset Management Team of 1832 Asset Management L.P. His primary focus is MD’s North American equity funds and pools.

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