Tim Duy’s Fed Watch, 9/22/21

Published on September 22, 2021
SGH Insight
Looking ahead, my instinct is the Fed’s inflation forecast for 2021 is still too low; 3.7% feels like a minimum that I suspect depends on used car prices collapsing. The unemployment forecast for this year reflects the growing concern we had noted across the Fed that the labor force was not returning as quickly as expected, but now feels perhaps overly cautious to me. We are at 5.2% now; an exceptionally good report could take that to 4.8% in one fell swoop. Together that suggests that the December dots will move the majority expectations of a rate forecast to a full hike in 2022.

Market Validation
Policy Validation

Bloomberg 10/13/21

The U.S. added fewer jobs than forecast for
a second month in September, signaling weakness in the labor
market recovery and complicating a potential decision by the
Federal Reserve to begin scaling back monetary support before
year end.
Nonfarm payrolls increased 194,000 last month after an
upwardly revised 366,000 gain in August, a Labor Department
report showed Friday. The unemployment rate fell to 4.8%, while
average hourly earnings jumped.

Fed Sets Stage for November Taper

The FOMC meeting ended largely as we anticipated with the Fed setting the stage for tapering at the next meeting while revealing a more hawkish set of rate forecasts. The key addition in the FOMC statement:

Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals. If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

We anticipated this signal. The language clearly guides us to expect that the Fed will taper asset purchases at an upcoming meeting while the modifier “soon” strongly implies November. In his opening statement, Federal Reserve Chair Jerome Powell added this:

We also discussed the appropriate pace of tapering asset purchases once economic conditions satisfy the criterion laid out in the Committee’s guidance. While no decisions were made, participants generally view that, so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate.

This matches our expectations and reflects our sense that there was broad consensus already across the FOMC for both a November start date and a mid-year conclusion to the taper process, but it was more guidance on the duration of tapering than we anticipated at this time. In the Q&A, Powell went further and explicitly confirmed this “broad” support for this timing and duration of tapering, another hint that the decision has basically already been made. In addition, Powell added this during the Q&A:

>>CHRIS RUGABER: If I can quickly follow up. How much of that will depend on what kind of jobs report we get for September? I mean, are you in a dated dependent phase where you need to see certain numbers going ahead or are we at a point where we have accumulated enough progress?

>> JEROME POWELL: It’s accumulated progress. For me, it wouldn’t take a knockout great super strong employment report. It would take a reasonable good employment report for me to feel like that test is met. And others on the committee, many on the committee feel the test is already met. Others want to see more progress. We will work it out as we go. But, I would say in my own thinking, the test is all but met. I don’t personally need to see a very strong employment report, but I like to see a decent employment report. Again, it’s not to be confused with the test for lift off, which is so much higher.

Note that Powell deemphasizes the nonfarm payroll numbers in favor of the overall “employment report.” There is plenty of room there for a weak headline payroll number to be offset by other factors like a decline in the unemployment rate, which means another report like the last would be sufficient to begin tapering. Importantly, rather than explaining just the Committee’s views, Powell makes the rare move of giving his own views, saying that all he needs is a “decent” employment report, and repeats twice that in his view the test to taper is “all but met.” Again, this is as explicit guidance as reasonably imaginable that the decision has essentially been made barring a disastrous turn of events, of which the possibility of a debt ceiling crisis stands out. Overall, Powell positions the Fed as aligned with our long-held view that the Fed was ready to taper, the consensus was circling around November, and the Fed just needed one more meeting to iron out the details, move past the debt ceiling issue, and ease the taper as promised into the markets. The only surprise here to me was that this was laid out more or less explicitly; I didn’t anticipate this much guidance at this meeting.

The economic forecasts in the Summary of Economic Projections fell in line closely to our expectations. The median growth rate in 2021 is now 5.9%, down sharply from 7.0% in June, but much of the loss was pushed out into 2022 and even 2023; we anticipated that the growth lost from supply side constraints this year would be made up next year. The 2022 forecast for unemployment rose from 4.5% to 4.8% but was unchanged for 2022 and 2023; we anticipated little change in the outer years forecast and expected that after the late 2021 Delta related constraints the powerful momentum on the labor side would be seen to continue essentially unabated. The core PCE inflation forecast for 2021 was revised up from 3.0% to 3.7% and rose in 2022 to 2.3%, both exactly in line with our projections. Core inflation remains elevated in 2023 at 2.2%. The overall story from the inflation projections confirms our view that the Fed, including the Board, believes this year’s inflation surge is largely transitory, but that it is increasingly viewing underlying inflationary pressures including the likelihood that rolling supply shocks will continue through the middle of 2022 as exerting more persistent upside pressure than it did in June.

And that brings us to the dots. The dots drifted upwards as we expected but overall were even slightly more hawkish. Two FOMC participants flipped to expecting a rate hike in 2022, a 9-9 tie technically pulling a half of a rate hike int the median expectation into 2022, but just shy of the one more vote needed to pull the majority into a full 0.25% rate hike that we expected. 2023 and 2024 rate forecasts indicated that the median policy maker anticipates three rate hikes in each year compared to the two on balance each year, with the risk of three, that we expected. The message from the dots is that a large contingent of participants expect the Fed will need to push policy rates toward neutral a bit faster than I anticipated. This likely reflects the 2024 forecasts of a fourth consecutive year of above-target inflation and a third consecutive year of unemployment below what may be consistent with full employment. Still, even then, the 1.75% policy rate projection for 2024 remains below the 2.5% longer-run rate. Policy under the new framework is thus more dovish than prior to the pandemic but, as we have repeatedly written, is not “crazy” dovish.

Looking ahead, my instinct is the Fed’s inflation forecast for 2021 is still too low; 3.7% feels like a minimum that I suspect depends on used car prices collapsing. The unemployment forecast for this year reflects the growing concern we had noted across the Fed that the labor force was not returning as quickly as expected, but now feels perhaps overly cautious to me. We are at 5.2% now; an exceptionally good report could take that to 4.8% in one fell swoop. Together that suggests that the December dots will move the majority expectations of a rate forecast to a full hike in 2022.

Bottom Line: The Fed has zeroed in on a November tapering decision and Powell revealed a clear intent to move at that meeting barring a sharp turn in the economy. Between that and the stated broad support for ending asset purchases around the middle of next year, the Fed has pretty much made the tapering decision. A little bit more guidance and the Fed could easily have tapered today but I suspect the debt ceiling debate was a sticking point (plus it would have been too hawkish of a surprise). It’s early, but I think in December the dots will shift upward again and bring a full rate hike firmly into 2022.

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