Citi Personal Wealth Management

The Fed
Decides to Taper

Market Reaction: November 3, 2021

Key Thoughts

As widely expected, the Federal Reserve decided to taper its monthly bond purchases by $15 billion each month ($10 billion in Treasuries and $5 billion in agency mortgage-backed securities). Prior to this announcement, the Fed was buying $80 billion of Treasuries and $40 billion of agency mortgage-back securities each month. Importantly, this monthly reduction has only been ordered for November and December. Beyond that timeframe, the Fed is prepared to adjust the pace if warranted by changes in the economic outlook. Presumably, this means that the pace could be reduced further if inflation stays elevated.

Interestingly, the Federal Reserve changed its tone on inflation very slightly. In past statements the Fed said, “Inflation is elevated, largely reflecting transitory factors.” However, in the November statement, the Fed said, “Inflation is elevated, largely reflecting factors that are expectedto be transitory.” While a slight change in wording, this highlights the ongoing debate, which is whether the Fed should take action to tamp down inflation or should it wait to see if inflation fades on its own?

Currently, financial markets appear to be leaning towards the former with the forward curve structure pricing in two rate hikes in 2022 while the Fed is still leaning towards the latter by not projecting a first ratehike until 2023. Chair Powell stated during his press conference that, “It is time to taper we think because the economy has achieved substantial further progress toward our goals measured for last December. We don’t think it’s time yet to raise interest rates.” He also stated, “The inflation that we’re seeing is really not due to a tight labor market. It’s due to bottlenecks and it’s due to shortages and it’s due to very strong demand meeting those.” While he acknowledged that supply bottlenecks and pressure prices may last well into next year, he still expects inflation to moderate by the second or third quarter of 2022. He also stated that the Fed will not hesitate to use its tools to fight inflation if price pressures stay higher for longer. Citi Global Wealth also believes that inflation will moderate in 2022 as supply bottlenecks ease and fiscal stimulus does not repeat.

The initial reaction from risk assets appeared to be positive with U.S. stocks rallying a touch as Chair Powell seemed to describe inflationary pressures as a problem that is not permanent or unsolvable. The next key news regarding the Fed may be whether Chair Powell is renominated with his term set to expire in February 2022. While the odds seem to favor his renomination, it is still possible that the current policy prescription could change if Chair Powell is not renominated.