Reflecting progress in the US, the Federal Reserve did tweak its assessment of the pandemic risks facing the economy, scaling back its view from ‘considerable’ risks to the more vanilla ‘risks remain’.
Fed Chair Powell reiterated his view that ‘base effects and (supply) bottlenecks’ were likely to drive up inflation in the coming months, but that neither were likely to shift inflation expectations or the medium-term outlook for inflation.
In the Fed’s view, the process of reopening the economy could be bumpy as new businesses emerge and supply moves back into line with demand, potentially even lasting into 2022.
Ultimately, however, even if the process is a little protracted, it won’t change where inflation is going to be in 2023 and beyond.
On the labour market
Despite the shrinking of the risks to the outlook, Powell emphasised that the economy is still a long way from where the Fed wants to get to, with the shortfall in the labour market still measured in many millions (see Exhibit 1 below).
He welcomed the March employment report which revealed the economy created 916 000 jobs. He was asked how many more good readings the Fed would need to see to begin at least talking about the possibility of tapering the QE programme. He didn’t give a direct answer, but stressed one report is not enough.
Watch the labour market between now and June
That likely leaves the end-June FOMC meeting as the earliest point at which the Fed could begin to have a discussion about when to taper QE. Powell has repeatedly said this will be a drawn-out process with lots of prior notice. This can be seen as an attempt to avoid a 2013-style 'taper tantrum'. His comments suggest that actually commencing the taper much before the end of 2021 will be tricky.
The actual process is likely to take the best part of a year (perhaps over six FOMC meetings, there being eight a year). While it’s not possible to directly read off when market pricing expects the taper to begin, the fact that there is about a 2-in-3 chance of a rate rise priced by the end of 2022 suggests that a taper in late 2021 (if it happens) should come as little surprise.
In summary, don’t expect any major change in tone from chair Powell until the US labour market is looking a lot better.
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