Federal Reserve Chair Jerome Powell’s comments at last Friday’s virtual Jackson Hole Economic Symposium received different interpretations from the financial media, but the bond and stock markets seemed to understand that the Fed isn’t going to be embarking on any significant change in its accommodative policies in the near future; i.e., don’t worry about the taper.
According to the Wall Street Journal’s headline, “Powell Says Fed Could Start Scaling Back Stimulus This Year.” But Yahoo Finance had a much more circumspect take. Its headline read: “Powell: Reversing Fed stimulus too early could be 'particularly harmful.’”
“Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful,” Yahoo quoted Powell as saying, although further down in its story, it added an additional quote: “If the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.”
As several other Fed officials stated, that seemed to seal the deal that the Fed will start the asset tapering process sometime in the fourth quarter and maybe wrap it up early next year. Left up in the air is exactly how much the Fed plans to taper and at what point it will stop, although Powell made it sound like it may not happen at all if economic changes intervene. In any event, the markets seemed to like what Powell said, as stock prices rose and bond yields fell.
We keep hearing about tapering and why the Fed should or shouldn’t do it, but how much can the Fed actually taper in such a short period of time without disrupting the markets? The answer is only a little. First, the Fed still has an $8 trillion balance sheet that will continue to grow, even if it may grow slightly more slowly going forward. Second, remember, tapering only means the Fed is going to buy fewer bonds than it has been doing, which is still a lot. So any tapering is going to be relatively painless and short-lived—if it tapers at all, of course, as Powell left open the possibility.
This whole discussion reminds me of when Ronald Reagan was first elected president back in 1980. Back then, the discussion was about so-called “budget cuts,” and the point then was to scare the electorate—which had just swept Reagan into office by a huge majority—into believing that we were all in for a lot of pain and suffering when the new administration began taking an ax to the budget. But, of course, in Washington, a budget “cut” simply means that if spending went up 10% last year and this year the plan is to raise it only 8%, that constitutes a “cut.” In other words, nothing is cut; it just doesn’t go up as much as the previous year. (Now, of course, nobody in Washington talks about budget cuts anymore).
Tapering is no different. The Fed is currently buying $80 billion per month of U.S. Treasury securities and $40 billion of mortgage bonds. So, if it reduces those purchases to, say, $75 billion and $35 billion, yes, that does constitute a tapering, but hardly anything to get worried about. The fact is, the Fed is still buying lots of bonds. Now, if the Fed suddenly said it would stop buying bonds and actually let its huge bond portfolio start to run off, that would be a completely different story. But of course, that is not going to happen, and may not for another five or 10 years at this rate.
And the reason, of course, is that federal budgetary pressures won’t allow it to do so. Last week Nancy Pelosi’s House Democrats passed a $3.5 trillion budget bill, to be followed by a $1 trillion infrastructure bill, which you know President Biden will be more than happy to sign. With so much more borrowing on the horizon, the Fed simply can’t stop financing the federal deficit without igniting even more inflation.
Of course, the Fed could fight inflation, if it felt it had to, by raising interest rates, but that is so far in the future it’s not even on anyone’s radar screen.
In a nutshell, all this talk about tapering is just that—talk. If it happens, you won’t even notice it.
Giving the devil his due, maybe Powell is right to caution against jumping the gun on tapering too soon. The Delta variant has thrown a hard curve at the economy. Many companies that had started to or were planning to call their employees back to the office are delaying those plans. Some people are starting to alter their behavior. We’re probably not headed back to the lockdown of 2020, but more cautious consumers mean less economic growth.
All of which means that the Fed’s financial party will go on. Let the good times roll!
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.