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The Fed prepares to tighten: five takeaways from its latest meeting

The Federal Reserve’s meeting this week concluded with a clear message: monetary policy in the US is about to become a lot tighter.

Not only did the central bank set the stage for an announcement in November on the phasing out of its massive pandemic-era stimulus programme. It also provided fresh insights on when and how quickly officials expect interest rates to rise.

But monetary policy was not the only topic on the agenda. Here are five things we learnt from Fed chair Jay Powell’s press conference on Wednesday:

Tightening the monetary policy screws

No topic has gripped financial markets more than the timing of the Fed’s decision to begin reducing or “tapering” its $120bn-a-month asset purchase programme. The stimulus was introduced at the onset of the pandemic last year and the Fed pledged to keep it in place until it saw “substantial further progress” on its dual goals of average 2 per cent inflation and maximum employment. 

In his most specific discussion of the taper to date, Powell on Wednesday revealed the US economy will probably be on a firm enough footing for the Fed to announce a reduction of the bond-buying programme at its next meeting in November. And he disclosed the Federal Open Market Committee broadly supports a “gradual” taper, with the intention of withdrawing the stimulus entirely around the second half of next year. 

There was also a marked shift in the projections for interest rate increases pencilled in by Fed officials. More policymakers now expect an interest rate increase next year, with the 18-person committee evenly split on the prospects of a 2022 increase. An additional rate rose was added in 2023, suggesting at least three adjustments by the end of that year. 

Investors took the faster tightening timeline in their stride, with the S&P 500 closing higher on Wednesday.

“There was a lot of information to digest, but I don’t feel like anyone felt caught-out by it, which is exactly what the Fed had promised to do,” said Megan Greene, a senior fellow at Harvard University’s Kennedy School of Government. 

Debt ceiling woes

Powell added his name to the list of heavy-hitting policymakers to warn of the consequences should US lawmakers fail to raise the debt ceiling.

Treasury secretary Janet Yellen recently said the US government could run out of money next month unless Congress acts, but Republicans and Democrats appear no closer to a resolution despite the rapidly approaching deadline this month.

Should the US default on its debt, it risks inflicting “severe damage” to the economy and financial markets, said Powell, adding: “It’s just not something that we should contemplate.” He also cautioned against anyone assuming the Fed or “anyone else” can “fully protect” financial markets or the economy in such an eventuality.

A debt ceiling debacle would throw off the Fed’s tapering timeline, said David Kelly, chief market strategist at JPMorgan Asset Management: “That would of course change their timeline. It would change the entire global economic outlook.”

Conflicted interests

The Fed chair also shared more details about the review the institution has launched into trading by senior officials, after regional presidents Robert Kaplan and Eric Rosengren were found to have actively invested during a year when the central bank was working in overdrive to bolster financial markets. 

Powell acknowledged that as a general principal, Fed officials should not own the assets the central bank itself is buying, and pledged to conduct a “thoroughgoing and comprehensive review” of the its ethical rules and standards, which he said it would look to tighten. 

“No one on the FOMC is happy to be in this situation [and] to be having these questions raised,” he said.

Powell noted that the Fed’s unprecedented interventions in financial markets had meant that he too was holding some securities — municipal government bonds or munis — that had also been bought by the central bank. But he stressed the Office of Government Ethics had ruled he was not conflicted. 

“Munis were always thought to be a pretty safe place for a Fed person to invest because, as you know, the lore was that the Fed would never buy municipal securities,” the Fed chair said.

“Then comes the Covid crisis and I reversed that policy . . . without hesitating. The reason was that the financial markets, including the municipal financial market, were very much on the verge of collapse.”

Credit contagion?

Fears of contagion from the debt crisis at the Chinese property giant Evergrande have rippled across markets this week, but Powell said he believed that the situation was “very particular to China”.

While there is no evidence of significant direct US investor exposure to Evergrande, nor for Chinese banks, Powell did acknowledge that the crisis could affect investor confidence, which in turn could strain financial conditions.

Some analysts said, however, that there might be knock-on effects if Evergrande’s difficulties presage a broader economic slowdown in China, where the property sector makes up about 30 per cent of gross domestic product.

“Chinese activity and growth trends in China do impact the global trade cycle, the global commodities cycle and the global investment cycle,” said Tiffany Wilding, North American economist at Pimco. 

“If they are slowing down, which we think they are, that is going to have reverberations through the global economy and that will spill over into the US.”

Renomination

The Biden administration has so far remained tight-lipped about its plans to reshape the Fed as it weighs whether or not it will renominate Powell for another term. Powell, whose term expires in 2022 and is widely expected to hold on to the top slot, ducked any inquiries about his fate at the Fed.

“I think the phrase goes, ‘I have nothing for you on that today’,” he quipped. “I’m focused on doing my job every day for the American people.”

Powell did indicate, however, that he would welcome regulatory changes to the banking sector from the central bank’s next vice-chair of supervision, who will be nominated after incumbent Randal Quarles ends his term next month.

Analysts have speculated that Fed governor Lael Brainard is in the running for Quarles’s position. Brainard has also received backing from many progressive Democrats as a potential replacement for Powell.

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