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Fed: Asset purchases start to decline at $15 billion pace from this month

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As expected, the FOMC took the first step towards ending the ultra-expansive program aimed at protecting the economy from Covid-19, while keeping the benchmark policy rate in the range of 0 – 0.25%. While the Fed said it would begin cutting its monthly asset purchases at a pace of $15 billion a month later this month, it expressed less certainty that the jump in inflation would be temporary. This shows that the Fed has adjusted its inflation temporary rhetoric to be more cautious, open-ended and able to accelerate the tapering acceleration when necessary. While the Fed stated that it will reduce Treasury purchases by $10 billion and mortgage-backed securities by $5 billion, if it continues at such a steady pace, the program will expire in 8 months in June 2022. However, if the inflation anxiety increases, the Fed may have to go at a steeper pace, which means that the time to raise interest rates will be earlier. Under normal circumstances, the end of QE does not mean an increase in interest rates. The facts arising from the Fed statement;

 

·        High inflation reflects factors that are expected to be mostly temporary. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to significant price increases in some sectors.

·        Progress in vaccines and easing supply constraints are expected to support the decline in inflation, as well as continued gains in economic activity and employment.

·        The Committee decided that similar reductions in the pace of net asset purchases each month would likely be appropriate, but is ready to adjust the pace of purchases if warranted by changes in the economic outlook.

·        It has been reiterated that rates will be kept close to zero until the economy reaches maximum employment.

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The fact that we want to highlight here; The Fed says, “Yes, we think inflation still reflects temporary factors from the pandemic and will return to normal in the long run (we are not sure when, it may take longer)”. On the other hand; “If the business turns out to be more serious than we hoped, we will reduce asset purchases more quickly if necessary and terminate the program. If this does not happen, we will continue to support the economy and provide liquidity to a certain extent.” The caveat here may be: We are still unsure of employment and employers may find it more difficult to fill job positions due to the situation of firms (inflation means higher costs, plus production slows down due to supply-demand mismatch means employment slows down) and the situation of households. Various measures of the labor market remain weaker than pre-pandemic levels, and policymakers are still debating whether to use pre-Covid-19 conditions as benchmarks given the market that has changed tremendously over the past two years.

 

The tapering rate theoretically makes a rate hike possible in the second half of 2022. If the path drawn looks like the process will be completed in June, inflation risks could change the situation as supply chain bottlenecks trigger shortages amid strong demand. The Fed’s preferred measure of inflation was 4.4% in the 12 months ended September, the highest in three decades, more than double the central bank’s target. High inflation and uneasiness can also affect the longer-term side and break the anchor. Especially if we take into account the secondary effects of pricing. According to the Fed’s preferred PCE benchmark, inflation is expected to be 4.2% in 2021, compared to 3.4% in the June FOMC. We need to see if there is an additional change in December.

 

The expectation of a more aggressive, anti-inflationary slope regarding the Fed policy may increase real interest rates. Powell said on October 22 that it would be “early” to raise interest rates because of the recession in the labor market. In his speech on November 3, he said that this is not the subject of today’s test on the rate hike. It is clear that he wants to see a clearer picture, because we are not yet at the point where we can be sure of the impact of supply bottlenecks. Moreover, it is unclear whether Elvis will have left the building when the tapering is finished; Biden has yet to appoint Powell for his second term.

 

Meanwhile, the U.S. Treasury announced the first cut in three-month long debt sales in more than five years, reflecting declining borrowing needs as the wave of pandemic relief spending recedes. The Treasury said it will sell $120 billion in long-term securities at auctions next week. That’s about $6 billion less than the record levels seen in the last three so-called quarterly repayments. With the exception of inflation-linked debt, more scaling will take place in regular auctions of all long-term securities in the coming months.

 

Fed interest rate expectations of economists for future periods. Source: Bloomberg

 

As a result; The Fed did not take a different step than the market expected and remains in the middle of raising interest rates. So the indices are generally happy. On the other hand, within the framework of the uneasiness about inflation and the contribution of supply / demand mismatch, the Fed will keep the policy open-ended and in a direction that will accelerate further if necessary. This means that fear of higher and persistent inflation pushes normalization forward. Real interest rates will also react to such a phenomenon. In the employment data on Friday, the details of wages are very important; Especially after that, it may be necessary to look more closely at factors such as rent and wage inflation. Of course, the Fed cannot solve policy and supply problems, but factors related to financial conditions and firm costs can create a complex composition that will cause the business to get into a complicated situation.

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