What investors are watching from the Fed: talk about tapering and inflation

Investors will look at the Federal Reserve’s comments at the close of its policy meeting on Wednesday to see if the central bank has started discussing declining bond purchases and if policymakers are concerned about rising inflation. A possible rise in certain short-term key rates is also on the agenda. Here are the topics investors are focusing on:

TALKING ABOUT TALKING ABOUT A CNE

The Fed is keen to minimize the possibility of a market disruption when it begins to scale back its $ 120 billion per month government bond and mortgage-backed securities buying program.

Market participants will focus on whether this has progressed in any way, with a reduction in bond purchases set to be the first step in the Fed’s normalization of its ultra-accommodative monetary policies.

Signs that the Fed may decline sooner than expected could trigger a bond market sell-off, which could hurt risk appetite and push stocks lower.

Many analysts believe the Fed will wait for any announcements of bond cuts until its economic symposium in Jackson Hole in August, with a cut unlikely before the end of this year or early next year. Some market participants, however, fear that there are dangers to be expected while the inflation numbers are strong.

IS INFLATION REINFORCED?

Inflation has become well above the Fed’s 2% target as the economy reopens and investors will be watching for signs that policymakers are uncomfortable with recent increases.

Data from last week showed that consumer prices in May recorded the largest annual increase in 13 years, with a gain of 5%.

The US Treasury market showed little concern with the data, however, with yields falling to three-month lows. Ten-year yields were 1.46% on Monday and fell from a one-year high of 1.78% in March.

Fed Chairman Jerome Powell said after the US central bank’s April meeting that transitional inflation increases expected this year would not meet its standard of rising interest rates.

WILL THE DOT PLOT SHOW AN EXPECTED RATE INCREASE IN 2023?

Market participants will focus on when policymakers see a rate hike, a section of the Fed’s economic projections known as the “dot plot.” ”

Seven of the 18 officials are expected to hike rates in 2023 at the Fed’s March meeting, up from five in December. Four officials also estimated that rates may have to rise as early as next year, a change from zero in the latest December projections.

Meanwhile, any increase in inflation projections for 2022 and 2023 may indicate that the Fed considers inflation increases to be more persistent than expected.

AS REPO REPO VOLUMES REACH RECORDS, WILL THEY BE HIGH “IOER”?

Another key focus will be whether the Fed tackles the turmoil in the cash markets by increasing the interest it pays banks on excess reserves and the rate it pays on overnight repurchase agreements. the Treasury is reducing bond issuance at the same time as banks grapple with excess deposits, in large part due to the Fed’s bond purchases.

The Fed’s reverse repurchase facility, which offers licensed fund managers the ability to lend money to the Fed overnight in exchange for Treasury guarantees, has seen increasing demand and hit a record high of $ 584 billion on Monday. Demand is expected to continue to grow as the Treasury continues to reduce Treasury bill issuance and the debt ceiling gets closer.

By increasing the IOER, the Fed can ease some downward pressure on short-term rates. Some analysts say the Fed is unlikely to make any adjustments unless the fed funds rate falls below 5 basis points, a level it has so far held above. The federal funds rate was at 6 basis points on Friday.

EASE OF PERMANENT REPO

The Fed surprised some market participants when the minutes of its April meeting, released in May, showed policymakers attending a briefing on the pros and cons of making the support they provide to money markets permanent. .

Investors will be looking for any details the Fed could give on a permanent repo facility, which would reduce the risk of the Treasury market experiencing the kind of liquidity shortage that hit the markets in September 2019 and March 2020 by giving investors assurance that there is a lender. of last resort in the event of a new major disruption.

Our standards: Thomson Reuters Trust Principles.

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