The Federal Reserve (Fed) meets this week to discuss its ongoing support for the U.S. economy. During its regularly scheduled two-day meeting, the nineteen-member committee is expected to discuss if and when the Fed should start to remove the emergency level monetary accommodation that it has provided since the beginning of last year’s COVID-19 shutdowns. Last month’s meeting sparked some market volatility as some of the comments, along with the data releases, were interpreted as a shift in tone to be slightly less accommodative. While we won’t be getting the same type of data releases at the conclusion of this meeting, that doesn’t mean the market can’t (over)react to what is and isn’t said. Below are some of the things we’ll be watching for.
“We’re not expecting fireworks at this Fed meeting,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “But we are expecting the committee to go further down the road in discussing the when and how to start removing the emergency level monetary accommodation it has been providing markets.”
- Any changes in the language in the post-meeting statement. At the conclusion of Federal Open Market Committee (FOMC) meetings, the Fed releases its post-meeting statement summarizing the outcome of the meeting. Generally included is the committee’s assessment of the economy and potential risks to its recovery. Notably, the committee downgraded the COVID-19 risk last month. However, the committee may reinsert that language given the uptick in cases due to the Delta variant. An acknowledgement would likely indicate the committee’s hawkish shift last month may have been premature.
- More discussion around reducing the bond buying programs. The Fed currently purchases $120 billion of debt securities every month ($80 billion of Treasury and $40 billion of agency mortgage securities) to help provide liquidity and to support financial markets. In previous meetings, Fed Chair Jerome Powell has said that it’s too early to talk about reducing that support. While we don’t think the Fed is ready to announce the start of the tapering process, we do expect the committee to announce that those discussions are taking place with a formal tapering plan coming in the next few months.
- Still too early to talk about raising short term interest rates. The Fed has said that it would like to reduce its bond buying programs before it starts to increase interest rates. At the end of the day, the market is more concerned about rising interest rates than the tapering of bond purchases. Historically, when the Fed starts to raise interest rates, economic growth tends to slow. The market will be looking for any hint of when that process will start. Markets don’t expect that to take place for another year or so. Any suggestions otherwise will likely increase market volatility.
As seen in the LPL Research Chart of the Day, market expectations for when the Fed will start to raise short-term interest rates have changed over the past month. Largely due to the expected slowdown in economic growth due to the COVID-19 delta variant, the market now thinks the Fed will wait until the first part of 2023 to hike rates. Moreover, the expected path of interest rates over time has come down slightly with the market only pricing in four 25 basis point (0.25%) interest rate hikes over the course of the next five years.
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