Precious Metals London talking point 110421; Fed outlines tapering plan - Powell projects inflation and employment outlook

By: Rhona O'Connell, Head of Market Analysis

Thu, 04 Nov 2021, 11:44

Fed outlines tapering plan – Powell projects inflation and employment outlook.

Inflation likely elevated until at least the second quarter of next year.
Bottlenecks to last “well into next year”
If the recent pace of economic recovery persists, maximum employment is possible in the second half of next year
Wages are not (yet?) increasing at a higher rate than inflation
Given these parameters the Nonfarm payroll figures and their components tomorrow will be key

The Fed’s tapering plan kicks in later in November – but note that inside the wording the Fed continues to talk of net purchases of “at least” the appropriate amounts, thus maintaining its scope for flexibility.

There was little in there to surprise the markets and the prospect of negative real interest rates for the foreseeable future sustains the tailwinds for gold, even if, as Jay Powell projects, the United States does not move into a wage spiral that would boost inflationary forces. And in the background, of course, nominal interest rates in Europe are largely negative.

U.S. yield curve, today and a month ago

image-20211104114527-1

Source: Bloomberg

In his Press Conference, Jay Powell said the following: -

“We understand the difficulties that high inflation poses for individuals and families, particularly those with limited means to absorb higher prices for essentials such as food and transportation. Our tools cannot ease supply constraints. Like most forecasters, we continue to believe that our dynamic economy will adjust to the supply and demand imbalances and that as it does, inflation will decline to levels much closer to our 2% longer run goal. Of course, it is very difficult to predict the persistence of supply constraints or their effects on inflation. Global supply chains are complex. They will return to normal function, but the timing of that is highly uncertain. We are committed to our longer run goal of 2% inflation and to having longer term inflation expectations well anchored at this goal. If we were to see signs that the path of inflation or longer-term inflation expectations was moving materially and persistently beyond levels consistent with our goal, we would use our tools to reserve price stability. We will be watching carefully to see whether the economy is evolving in line with expectations.

With respect to tapering he understandably underlined that the pace of tapering would be adjusted subject to changes in the economic outlook, and that “even after our balance sheet stops expanding, our holdings of securities will continue to support accommodative financial conditions”

Spot gold, inverse of the dollar and the correlation

image-20211104114527-2

Source: Bloomberg

When asked whether the markets are wrong in expecting the Fed to raise rates once or twice next year, he said that the baseline expectation is for supply bottlenecks and shortages to persist “well into next year” abating as the virus subsides, bringing inflation down. The timing is highly uncertain, but they certainly expect inflation to be coming down by the second or third quarter. The Fed thinks it can be patient but “If a response is called for, we will not hesitate” and in follow-up, yes, he does think that if the recent pace of economic recovery continues then maximum employment could be achieved by the second half of next year.

Asked about wages, he notes that so far, at least, wages in general have, in recent months and as measured by the Employment Cost index, not been rising in real terms. If they were to be “rising persistently and materially above inflation and productivity gains, that could put upward pressure on or downward pressure on margins and cause companies to their employers really to raise prices as a result, and you can find yourself in what we used to call a wage price spiral. We don’t have evidence of that yet. Productivity has been very high”. They don’t see troubling increases in wages and don’t expect them to emerge, but they will be watching carefully

The Statement following the FOMC meeting gave the first concrete plans for tapering. Setting the scene, the statement noes that the sectors most adversely affected by the pandemic have improved in recent months “but the summer’s rise in COVID-19 cases has slowed their recovery. Inflation is elevated, largely reflecting factors that are expected to be transitory... The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain”.

The usual mandate still applies in terms of maximum employment and average inflation of 2% and is keeping the fed funds target at zero to ¼% - although the markets are taking a different view.

The tapering plan is as follows:

Net asset purchases are to be reduced by $10Bn per month and Mortgage-backed securities by $5Bn per month. -

Starting later this month, therefore, the longstanding pattern of the purchase of $80Bn of Treasury Securities and $40Bn of MBS therefore comes down to at least $70Bn and $35Bn respectively.

On this basis, therefore, the final month of purchases will be in May – subject, of course, to economic and financial developments. Rate hikes remain a way further in the distance.

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