With the emphasis on a tap, five questions for the Fed

NEW YORK, Sept. 20 (Reuters) – Investors are fixated on the Federal Reserve’s policy meeting this week as the US central bank nears the last quarter of the year, when it is expected to start cutting its level without bond buying precedent as a first step towards normalization of monetary policy.

Although investors expect the tapering to begin in 2021, there is still a lot of uncertainty as to when the Fed will announce and subsequently reduce bond purchases. The same is true when it then raises interest rates for the first time since 2019, before the pandemic causes it to cut rates to zero.

Here are five of the top questions investors will watch following the conclusion of the two-day Fed meeting on Wednesday.

BOND TAPERING – HOW MUCH IT IS NOW

Most Fed officials have expressed support for a reduction in bond purchases starting this year, as long as the labor market continues to improve.

While it is possible for the Fed to announce a cut from its $ 120 billion monthly purchases of treasury bills and mortgage-backed securities (MBS) this week, with purchases set to be cut as early as November, recent weakness economic data reduced the likelihood of such a move.

Employment data for August is well below expectations, while searing inflation spurred by reopening businesses after COVID-related closings shows signs of moderation. Read more

Investors are focusing on any new signals that indicate when a downturn may begin and whether the move will be tied to any concrete improvement in the data, including jobs. The Fed’s meeting in early November will take place before it sees the employment data for October, which could leave policymakers hesitant to make a decision until December.

The pace of a cut will also determine how long it takes to end quantitative easing, which is expected to end before the Fed hikes rates. Fed Chairman Jerome Powell, who is due to speak after the meeting’s statement, could also indicate that the Fed could speed up, slow down or stop any slowdown if economic conditions deteriorate.

THE PATH OF RATE INCREASES

The Fed has been careful to try to separate any schedule for cutting bond purchases from the zero rate hike for the first time since March 2020, but it may not be as easy as some think.

If employment continues to improve and inflation remains above target, the terms of reduction can also be considered the same for rates of increase.

The Fed scared investors in June after policymakers announced they were planning two interest rate hikes in 2023. read more

The dot plot, where Fed officials place their projections for the fed funds rate, this month will update whether those expectations have changed. It will also offer a first look at the expectations of Fed officials for 2024.

If rate projections up to that date are more hawkish than expected, interim bond yields, which are sensitive to possible rate hikes in this period, could rise.

Fed funds futures are valued for the first interest rate hike to occur in March 2023.

WILL HIGH INFLATION BE TRANSITIONAL?

The key argument behind when rates can be raised is whether the Fed will be able to wait to see the economic improvement it wants before tightening, or whether the spiraling pressures on price will force her to act.

The recent drop in prices will strengthen Powell’s argument that high inflation will prove to be transient. The inflation-indexed swap curve is on a downward slope, reflecting expectations that annual increases in the consumer price index have peaked.

But it’s not clear when the supply chain disruptions that have contributed to the rise in overall prices will subside. Moreover, the new restrictions on the potential spread of the coronavirus variants are a wild card as to whether inflation will continue to accelerate or remain at high levels.

Economic projections released on Wednesday are likely to show a wide range of policy makers’ inflation expectations that may differ depending on whether inflation risks are up or down.

ECONOMIC PROJECTIONS

Policymakers’ economic projections for growth and jobs, released with the dot charts after the March, June, September and December meetings, will provide insight into whether policymakers fear growth and economic growth. jobs will lag behind inflation, leaving the Fed at a deadlock on how to normalize policy.

Some investors fear that the US economy is entering a period of stagflation, during which price pressures increase even as growth is sluggish.

A Bank of America report released earlier this month showed that investors have ventured into assets that are seen to perform better in such an environment, while very few asset classes generally perform well. . Read more

MBS AND PROPORTIONAL CASH REDUCTIONS

Since the start of the pandemic, the U.S. central bank has bought $ 80 billion in treasury securities and $ 40 billion in mortgage-backed bonds per month.

Speculation that the Fed may cut mortgage-backed securities purchases before or at a faster pace than Treasuries have faded as Fed officials downplay the prospect that buying MBS has helped at record real estate prices across the country.

Powell said in July that he expects the Fed to reduce its purchases of Treasuries and MBS at the same time. Read more

Nonetheless, investors will be watching for any signs that this policy is being reconsidered.

Reporting by Karen Bretell; Editing by Alden Bentley and Dan Grebler

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