Get ready for the taper.
What happens when the Fed no longer buys the excess US debt???
That was the message from Jerome Powell and company at the conclusion of the Federal Reserve’s two-day monetary policy meeting Wednesday. The Fed said that barring any unforeseen negative developments—perhaps a worse than expected hit to the labor market from the Delta variant, a financial crisis arising from China, or a surprise further deterioration of supply chains—reducing the level of its bond purchases will be warranted soon. That all but assures that the Fed will announce the taper at its next meeting in November and begin it shortly afterward.
It is remarkable how little the Fed has been affected by actual economic data this year. The Fed first promised to keep up the bond purchases until “substantial further progress” was made toward the goals of maximum employment and price stability back in December 2020, when the unemployment rate was at 6.7 percent and the Consumer Price Index was running at 1.2 percent year over year. The forecasts of Fed officials had inflation running at 1.8 percent by the end of 2021 and unemployment at 5 percent. The economy was forecast to reach a growth rate of 4.2 percent.
It turned out that we got far more growth early this year, unemployment fell by more than expected, and inflation picked up pace far more than expected. The Fed now sees GDP growing 5.9 percent, unemployment falling to 4.8 percent, and inflation at 4.2 percent.
In other words, we reached the goal of “substantial further progress” long ago, and the Fed did nothing. Instead, it stuck to what many assumed was its original time table of beginning the taper in late 2021. The fact that the Fed claimed its policy was data-dependent but it now appears to be calendar-based may wind up undermining the Fed’s credibility.
Buckle up, it may gt ugly.