Federal Reserve Chair Jerome Powell seems to have
capitulated on plans to taper the Fed’s stimulus
program as of mid-July, causing the bond market to
rally and the stock market to hit new highs. But
economic data sets are still disappointing, and rising
interest rates and inflation are affecting consumers
now. As we remain uncertain about when the taper
comes, investors should expect more volatility.
Since the financial crisis brought upon by the COVID pandemic, the Fed has bought bonds to push down
real interest rates, in a bid to rev up economic activity.
In fact, currently, the Fed is on a monthly diet of $120
billion in monthly bond purchases. As a result, the
central bank’s balance sheet has ballooned to $8.2
A divided Fed?
As inflation moved higher and as jobless claims came
down, many rightfully expected the Fed to announce
that it plans to wind down this quantitative easing
(QE) program gradually. But since that announcement
hasn’t happened, the S&P 500, NASDAQ and the
DJIA continue to surge to new record highs.
However, there appears to be growing dissension
within the Fed’s ranks, as minutes of its most recent
meeting show that not everyone wants to remain on
board the runaway QE train. In fact, many of the Fed
members prefer to wind down asset purchases.
In recent testimony to the House Financial Services
Committee, Fed Chair Powell signaled no imminent
change in the Fed’s policies. And he continued to
repeat his opinion that high inflation readings over the
past several months (actually inflation has gone up
every month so far in 2021) were driven largely by
temporary factors, meaning supply shortages and
rising consumer demand as COVID-related business
restrictions were lifted.
Then Powell doubled-down by saying that the Fed
refused to respond to short-term price spikes by
raising rates and risk weakening the economic
“By inflation, we mean year after year after year
prices go up,” Powell said. “If something is a one-time
price increase… you wouldn’t react to something that
is likely to go away.”
“We really do believe,” he added, “that these things
will come down of their own accord.”
Inflation is rising fast
But the Fed’s current position is in stark contrast with
intensifying inflationary pressures being felt by
households and the threat to recovery is real. Just this
month the U.S. government reported that wholesale
prices – which businesses pay – jumped over 7% in
June relative to the year before. This was the fastest
such 12-month increase on record dating to 2010.
And guess who pays those increases?
Staying at the party too long?
The gist of the Fed’s comments is that QE must continue unless data supports ending it.
And by many measures, the Fed can justify
continuing QE for a long time.
The unemployment rate is still high and it is even
higher if you count the record number of part-time
workers not included as employed in the headline
number. The economy is growing at a high rate, but
it’s relative to the anemic rate from last year. And
whether inflation is transitory or not depends on which
economist you ask.
As an investor, it’s worth worrying that QE continues
too long, as we really don’t know what the Fed has up
its sleeve. Further, in his comments, Powell made it
clear that, even if the Fed tapers its bond buying, it
doesn’t mean there are plans to increase interest
rates. In fact, even if the Fed brings QE to a complete
halt, it doesn’t mean interest rates increase.
Powell said that the economy is “still a ways off” from
making the “substantial further progress” that the Fed
wants to see before they will begin reducing the $120
billion in monthly bond purchases. When he was
asked to clarify what he meant by “substantial further
progress,” he said this:
“It’s very difficult to be precise about it. We didn’t try to
write down a particular set of numbers that would
capture what we mean by that.”
Rates are going up at some point
At the most recent meeting Fed meeting, Fed officials
telegraphed that they may raise their benchmark
short-term rate twice by the end of 2023, much earlier
than they had previously signaled.
And given that the rates consumers and businesses
pay to buy homes, cars, equipment and other goods
are up so far in 2021, any rate hikes by the Fed will
just accelerate this trend. And that could harm the
economy. And markets.
Talk to your advisor to make sure you’re prepared.
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