Simplicity
Beijing time in the early morning of November 4, the Fed announced and launched the taper as scheduled, and the plan to increase the monthly reduction rhythm of $15 billion is also fully in line with market expectations, because the June interest rate meeting publicly discussed taper, the Fed continued to communicate with the market, so the taper policy has basically been digested by the market, corresponding to this round of taper avoided the last taper panic (taper tantrum) - Last time, due to the market's overwhelm on the taper, the 10-year US Treasury yield rose sharply by 140bps, from 1.66% to above 3%. This time, the 10-year Treasury yield was significantly weaker than in the previous round, and as of the meeting, the 10-year Treasury yield was only 3bps higher than at the end of the Meeting in June.
But unlike the last time, this time the short-term US Treasury yield has changed significantly, especially since late September, the short-term US Treasury yield has risen rapidly, last night's 3-year US Treasury yield increased by 36bps from the level after the June meeting, and the 2-year US Treasury yield increased by 26bps, showing that the market focus has shifted to the Fed's interest rate hike, although at the press conference, Powell once again stressed that taper has no direct signal significance for interest rate hikes, but the market has now expected the Fed to raise interest rates twice next year.
Figure 1: Us Treasury Yields by Maturity After the End of the Fed's Past Four Interest Rate Sessions Data Source: wind
In view of the huge divergence between market expectations and Powell's policy pronouncements, there is still a lot of uncertainty about the actual path of the Fed's interest rate hike in the later period, which requires starting from the constraints of the Fed's interest rate tool to analyze the recent new changes.
After the outbreak of the epidemic, for the Fed, an important event that attaches equal importance to the anti-epidemic stimulus is undoubtedly that the Fed adjusted the monetary policy framework after 10 years of operation last year, and the main contents of the adjustment are two:
One is to adjust the 2% inflation targeting (it) to an average inflation targeting (ait), that is, when inflation remains below 2% for a period of time, monetary policy tolerates inflation slightly above 2% for a period of time.
The second is to focus more on the realization of employment maximization by the three major monetary policy goals entrusted to it by Congress, that is, to move the goal of employment maximization to the two goals of price stability and moderate long-term interest rates, and adjust the indicators for observing employment from unemployment to employment gaps.
First of all, in terms of the employment gap, the conditions for interest rate hikes are basically met. The current unemployment rate in the United States is 4.8%, while the non-farm job vacancy rate has risen to 6.6% in the same period, and the difference between the unemployment rate and the vacancy rate has been negative (-1.8%). During the last round of policy regression to the Fed's rate hike cycle, the average of the difference was only -0.05%.
Second, in terms of average inflation, it seems that the conditions for raising interest rates are also preliminarily in reserve. In the new policy framework, the Fed only explicitly implements the average inflation targeting system, but the length of the observation period involved in the average inflation target is still not clear, which leads to the market's ambiguity about how the Fed will judge the degree of achievement of the inflation target. However, the Fed's new policy framework specifies that it will "conduct a thorough public review of its monetary policy strategy, tools, and communication practices every 5 years," perhaps implying that 5 years is the length of the observation period. Thus, starting in 2016 (5 years from the new framework in 2020), the real growth curve of the US PCE has exceeded the target line of 2% growth, indicating that the real inflation situation is close to the Fed's target.
Figure 2: Average inflation in the United States starting in 2016 Data source: wind
Therefore, only from the Fed's own policy framework, interest rate hikes are basically in place, coupled with treasury bond interest rates, investment-grade corporate bond interest rates and personal housing mortgage interest rates are at a low level, so from the actual situation of the implementation of the Fed's three major policy objectives, it does provide support for the later interest rate hikes.
Table 1: Achievement of fed policy objectives over different periods Data source: wind
In addition to the two constraints of its own framework mentioned above, there is a third constraint — U.S. fiscal sustainability. In response to the impact of the epidemic, the US government has implemented several rounds of fiscal relief plans, resulting in a rapid rise in the size of its debt, and the balance of US federal debt has approached 29 trillion US dollars so far, which has greatly exceeded the size of US GDP, so there are more and more concerns about the financial sustainability of the US government.
In addition, although the Biden administration plans to raise the US tax rate, the increase in tax revenue is very limited compared with its huge spending plan, so the US government's dependence on debt financing will be further increased. To this end, the US government did not hesitate to adjust the criteria for judging debt sustainability, and at the Senate nomination hearing when Yellen served as US treasury secretary at the beginning of this year, he clearly stated that compared with the size of debt, the scale of interest expenditure is the best guide to measure the space for government spending.
In fact, Yellen's statement is a major adjustment to the US fiscal policy and monetary policy coordination framework, for the Fed, not only through the asset purchase tool to be responsible for the government's debt financing scale, but also to use the interest rate tool to match the government's interest payment scale, which undoubtedly adds an important constraint to the Fed's interest rate policy - interest rate policy should pay more attention to the impact on the fiscal sustainability of the US government, then when the Fed opens the interest rate hike cycle, it is necessary to consider both the timing of interest rate hikes and the magnitude of interest rate hikes. In the latest round of interest rate hike cycle, the Fed gradually raised the federal funds rate from [0,0.25%] to [2.25%, 2.50%], and the corresponding real interest payment rate of the US government rose from 1.7% to 2.2%, which shows that the Fed's interest rate policy will indeed affect the US government's interest rate. In 2020, under the easing of the response to the epidemic, the US government's real interest payment rate quickly fell to an all-time low of 1.6%, during which the Fed's policy rate also returned to the level of zero interest rate lower.
Figure 3: U.S. Federal Policy Debt and Interest Rates Source: wind
But unlike the previous two constraints, fiscal sustainability is dynamic to the Fed's interest rate policy constraints, that is, the larger the debt size, the stronger the binding force, and the narrower the corresponding Fed's interest rate policy space. In view of the fact that after the impact of the epidemic, the dependence of the US economy on government fiscal expenditure has increased significantly, which in turn has led to a more close relationship between the US employment situation and government fiscal expenditure, which means that the third constraint also indirectly affects the first constraint. Therefore, there is great uncertainty about whether the Fed's interest rate hike path traded in the market can be implemented, and market expectations are not uncommon, for example, at the end of 2018, almost all market institutions expect the Fed to raise interest rates many times in 2019, but the Fed has cut interest rates twice in the same year, so on the road back, it is not possible to be too optimistic about the "distance" between the standard of interest rate hikes and the actual interest rate hikes of the Fed.
Editor-in-Charge: Zheng Jingxin