The Fed Turns Increasingly Hawkish

FOMC Minutes

Minutes of the last Federal Open Market Committee meeting (November 2-3), were released yesterday ^[1], offering a hawkish view. That meeting had produced the decision to begin tapering of the Quantitative Easing program (QE), by $15 billion in November and another $15 billion in December, without committing for the upcoming months ^[2].

Given that asset purchases were at the rate of $120 billion/month, the announced plan could lead to a conclusion of QE by June, after which the bank would look to start hiking rates, although there is no specific predefined road map for tightening sequencing.

Yesterday's accounts of that meeting, revealed that "some participants preferred a somewhat faster pace of reductions that would result in an earlier conclusion to net purchase".

On the topic of high inflation, which the bank believes is of transitory nature, members "concurred that it would be appropriate to convey less certainty about the path of inflation". Indeed, we believe officials have been less adamant lately, on their transitory view.

The other component of the Fed's mandate is employment, which remains at pre-pandemic and recovery in the labor market has been fragile. However, participants "anticipated better payroll numbers in the months ahead". The two Non-Farm Payroll prints that preceded the Fed's meeting, had been disappointing.

Powell Re-Nomination

US President Biden announced on Monday his intent to nominate Mr. Jerome Powell for a second term as Chair of the Board of Governors of the Federal Reserve System.

This put an end to recent speculation as to whether his term would be renewed or if the US President would opt to replace him. The main contender was Ms. Lael Brainard, who has been a member of the bank's Board of Directors since 2014 and was viewed by markets as the more dovish of the two.

This development further worked in favor of faster tightening expectations and seems to have made some Fed officials more open to such an outcome.

Fed Officials Comments

Between the Fed's last policy decision and now, we have seen a series of hawkish remarks by various ECB members, with the latest significant comments, coming from Ms Mary C. Daly.

In yesterday's interview with Yahoo Finance ^[3], the San Francisco Fed president, supported a faster tapering, saying that "If things continue to do what they've been doing, then I would completely support an accelerated pace of tapering".

Ms Daly has generally been on the dovish side and the above comments represented a stark departure from previous rhetoric. This adds gravitas to her opinion; however, she is not scheduled to be a voter in 2022.

One of the most vocal advocates of a more aggressive winding down of the asset purchases, has been the St. Louis Fed president, who will be a voter next year. Mr Bullard called again last week for faster QE tapering, to be concluded by Q1 next year and provide time to assess rate policy in a Bloomberg interview, also saying that Core PCE Inflation is quite high ^[4].

This week started with similar remarks from Mr Waller, who sits in the Board of Governors and is now pushed towards "favoring a faster pace of tapering and a more rapid removal of accommodation in 2022" ^[5].

Economic Data

The main driver for this hawkish shift in rhetoric, but also the beginning of the monetary policy normalization by the Fed, has been persistently high inflation.

The bank's preferred gauge of Inflation is the Core Personal Consumption Expenditures (PCE). The most recent data came in yesterday and showed a surge to 4.1% y/y in October, compared to 3.7% in September (revised from 3.6%). On a monthly basis, Core PCE rose 0.4% in October, compared to +0.2% in the preceding month.

Core readings do not take into account food and energy prices, which means that high gasoline prices in the US that led President Biden to strategic reserve releases, are not a reason for the high prices.

Price stability is one of the Fed's goals, with the other one being maximum employment. Things here have not been supportive of faster tightening, as the recovery of the Labor market has been fragile and inconsistent.

The last NFPs print however, showed the addition of 531 thousand jobs in October – a solid figure, after a couple of disappointments.

After the last monetary policy decision of November 4, Fed Chair Powell, had commented that monthly creation of 550K-600K jobs would be good progress ^[6].

More on the bright side, Wednesday's weekly Jobless Claims drooped to 199K, compared to 270K prior (revised from 268K).

GDP growth is another data set that we need be mindful of, when examining the path of monetary tightening, since recent data have not been stellar and we have also seen a series of downward revisions in projections.

The US economy grew 2.1% in Q3 (annualized) as per yesterday's second reading, marking a significant slowdown compared to the 6.7% growth of Q2.

The International Monetary Fund (IMF) downgraded its Growth projections for 2021 for the United States in October, to 6.0%, compared to 7.0%% in the previous July outlook.

Despite that, the IMF is optimistic about the next year, now forecasting 5.2% growth for 2022 vs 4.9% prior estimate. ^[7].^[8]

What's Next

This seeming hawkish shift has increased market expectations for a faster tightening path and has boosted the greenback, although these comments and views do not constitute official policy.

The next monetary policy decision is scheduled for December 15 and market participants will be eagerly awaiting for the updated staff economic projections. The dot-plot will be the in the spotlight, for an update on the rate hike intentions of Fed officials.