>> Core Ideas
The Fed officially announced and launched taper in November, exiting quantitative easing at its current pace ($15 billion/month) in June 2022. The Fed began to gradually face inflationary pressures, on the one hand, it still believes that inflation is a temporary pressure caused by a mismatch between supply and demand, and will observe inflation data in the future to decide whether to raise interest rates; on the other hand, it also mentions the inability of monetary policy to cope with supply problems. We believe that the decision of this interest rate meeting to implement taper at a faster pace does indeed reserve the initiative for interest rate hikes, but whether or not to raise interest rates in the future still depends on actual changes in inflationary pressures. Actually looking ahead to next year, we believe the probability of a Fed rate hike remains low. Once U.S. inflationary pressures ease and retrace in Q2 2022, and the risk of runaway inflation and self-realization of expectations is falsified (and long-term inflation expectations remain stable), the Fed will not need to raise interest rates, and the focus will remain on "stagnation" rather than "inflation". The stock trading event has not affected Powell's re-election prospects, and the Fed's policy style is still likely to continue in the future.
In terms of the scale of bond purchases, the Fed announced that it will officially launch taper in November, and will linearly shrink the scale of bond purchases ($10 billion treasury bonds + $5 billion mbs) every month in the future. At the current rate, the Fed will complete its exit from quantitative easing in June 2022. But at the same time, the interest statement also pointed out that if the economic outlook changes, it is also ready to adjust the scale of bond purchases. The overall tone is basically in line with the market expectations before the meeting.
In terms of interest rate range, the Fed maintained the benchmark interest rate of 0% -0.25%, and the reverse repo rate and the excess reserve rate (IOER) remained unchanged, in line with expectations.
>> acknowledges inflationary pressures but remains "temporary inflationary" overall, mentioning that monetary policy is weaker in responding to supply problems.
Second, the post-meeting statement mentioned that "supply chain problems have made inflation well above the long-term target of 2% and lasted longer than previously expected; inflation is still believed to be caused by the mismatch between supply and demand caused by the epidemic; the Fed toolbox is weaker in alleviating supply problems; still believes that the supply and demand gap will be bridged in the future, but the supply chain is more complex, the time for recovery is uncertain, and if inflation or long-term inflation expectations are consistently higher than our target, tools will be used to maintain price balance, and the future will continue to be cautiously observed." There is no direct link between the timing of exiting quantitative easing and the rate hike. ”
Overall, the Fed began to gradually confront inflationary pressures, on the one hand, referring to the inability of monetary policy to deal with supply problems, and on the other hand, mentioning that if inflation continues to exceed expectations, it will use price-based tools. We believe that the decision of this interest rate meeting to implement taper at a faster pace does indeed reserve the initiative for interest rate hikes, but whether or not to raise interest rates in the future still depends on actual changes in inflationary pressures.
We believe that the current two-front battle between the United States in the face of "stagflation" pressure is more clear, the government focuses on dealing with inflation, and the Fed responds to employment and growth. The relief of inflation pressure is mainly through Biden's domestic administrative adjustment and diplomatic mediation, including: one is to continue to pressure OPEC to increase production; the second is to accelerate the negotiation process of the Iranian nuclear agreement; the third is to partially ease with China in the field of trade; and the fourth is to accelerate the operation of US ports to alleviate supply chain pressure. In the short term, the Fed's focus is still on steady growth, and the monetary policy, which mainly plays a role in demand regulation, is weak in the face of supply-induced inflation problems. Considering the policy sequence of "shrinkage-rate hike-balance sheet reduction", the current stage of launching taper and striving to end quantitative easing near the middle of 2022 is only reserved for interest rate hikes (different from the exit method chosen by the camera in 2013), so that when the inflation risk exceeds expectations in 2022, it can act in a timely manner. But looking ahead to next year, we think the probability of a Fed rate hike remains low. Once the US inflation pressure gradually eases and continues to fall in q2 of 2022, the risk of inflation runaway and inflation expectations self-realization is falsified (and long-term inflation expectations remain stable), the Fed does not actually need to raise interest rates, but should be more cautious under the framework of average inflation targeting, to prevent excessive interest rate hikes from causing long-term inflation expectations to continue to fall back below 2%, forming a negative cycle of drag on real inflation. In the future, the Fed's policy focus will still focus on "stagnation" rather than "inflation".
Another uncertainty about monetary policy during the year came from the appointment of the Fed chair. We think the next Fed chairman is more likely to be nominated in November. Biden's comprehensive fiscal stimulus plan "Rebuild America Plan" has been smaller after experiencing a sharp contraction (from 3.5 trillion to 1.75 trillion), and moderate party members such as Manchin are still opposed at present, but it is expected that the pressure will gradually ease and the prospects for landing will gradually brighten, and Biden may gradually shift the focus of his work to the nomination of the Federal Reserve president and confirm the next chairman in November.
Judging from the current situation, Powell's prospects for re-election are still relatively bright. According to the existing statements, Powell is still a candidate supported by Yellen and Biden's senior advisory team. Even after the "stock trading storm", only Democratic left-wing lawmaker Warren publicly attacked and opposed the re-appointment of Powell. Compared with his main rival Brainard, Powell's Republican background has become his nomination advantage. In other words, Brainard, who nominated a Democratic background (compared to Powell, has a more hawkish view of bank supervision, advocating strengthening stress tests, financial institution liquidation reorganization tests, restricting financial institutions' dividend repurchases, etc.) may be heavily opposed by Republican lawmakers during the Senate voting process, but Powell, who nominates a Republican background, may have less resistance and does not need Biden to spend too much political capital. Overall, we believe that the possibility of Powell's re-election is still high, and the Fed's policy and policy style will still have strong continuity in the future.
Before the meeting, the market unanimously expected the Fed to announce the taper in November, and there was a slight divergence in the timing of the official launch (some expected to officially launch in December); finally the Fed decided to launch the taper immediately in November slightly faster than the market expected, but the overall tone did not deviate significantly (including not binding the rate hike to the taper time point, still believing that inflation is a temporary pressure, etc.). Looking ahead to future asset prices:
In terms of US Treasuries, we previously judged that the US Treasury yields in this round of rebound are difficult to break the previous highs within the year, especially after the taper announcement, the upward momentum will gradually exhaust, and at present, the view has been basically fulfilled; during the meeting yesterday, the US Treasury yields rose slightly after the announcement of the statement, and then fell back and basically gave back the previous gains, and the upward momentum was insufficient. Looking ahead, after the taper expectation landed on the market to fully price the upward risk of US inflation during the year (the 10-year inflation expectation has risen to near 2.6%), the US Treasury yield continued to rise sharply and the momentum is insufficient, and it is expected to show a wide range of shocks in the short term, and the center is slowly moving down.
In terms of US stocks, we previously firmly believed that the US stock market still has upward momentum after the phased correction in September, and this view has been gradually fulfilled; during yesterday's meeting, the US stock market also continued to rise, and the US stock market upward momentum was still sufficient in the absence of a signal of tightening beyond expectations. Looking ahead, in the context of the Fed's policy tone remaining largely unchanged (there has been no fundamental change in the perception of temporary inflation) and prominent US stock earnings data, the Dow and NASDAQ may continue to rise to new highs during the year, but Q2 2022 needs to be vigilant against the risk of US stock pullbacks.
In terms of the US dollar, we previously judged that with the landing of the taper expectation and the European replenishment will soon lag behind the launch of the United States, the US dollar index is expected to return to the downward channel during the year. Judging from the performance of the US dollar yesterday, the US dollar index went up and down after the announcement of the statement, and finally closed down slightly, and the short-term trend is in line with our previous judgment.
Risk Warning
The delta outbreak exceeded expectations leading to a prolonged easing cycle; higher-than-expected inflation led to a rapid tightening by the Fed.
This article originated from the Financial Circle Network