Fed Turning Hawkish

​The Federal Reserve left monetary policy unchanged, but there is a subtle change in the language which is hinting towards a path of tapering the Fed's QE asset purchases later this year. The combination of stimulus fuelled demand and supply side issues, inflation is becoming more persistent than the Fed expected and presents an increasing probability of a rate hike in 2022.

However, Fed Chair Jerome Powell is sticking to his story that inflation pressures are largely transitory and there is no need to signal an imminent shift in policy. Today's FOMC statement reiterated this position but we also see the hints that the Fed will start to taper later this year. The Fed funds target rate has been left at 0-0.25% with the monthly QE asset purchases left at a total of $120bn with a split of $80bn Treasury securities and $40bn agency MBS.

In previous statements, it was stated that these purchases would continue until “substantial further progress has been made” towards achieving maximum employment and the Fed consistently hitting its inflation target. However, the Fed has seen the data and knows that the “the economy has made progress towards these goals”. This is a significant step in the policy normalisation process.

With that said, the employment level in the U.S. remains more than 6 million lower than before the pandemic and with growing uncertainty about the trajectory and impact of the Delta variant, we don't think that tapering is imminent. We are just seeing a slow march towards this innevitable outcome as more FOMC members express their viewpoints on inflation running too hot.

Indeed, the Fed’s own 'dot plot' chart of individual members' predictions for the interest rate path has seven out of 18 FOMC members looking for a 2022 rate rise. It only takes three of the 11 members not favouring a 2022 rate hike as of June to switch sides to bring the medium in favour of action next year rather than 2023. 

To add fuel to the fire, the strong stimulus fuelled demand and suply side issues are leading to more persistent price pressure. The supply side is not keeping up with demand and hampering the recovery. This could show up in tomorrow's GDP data. In addiiton, the difficulties in finding workers to fill vacancies continues and this is leading to wage pressures

The June FOMC meeting saw Fed members shifting their collective view to 2023 as a starting point for interest rate increases. Its interesting that not so long ago, Fed members had their sights set firmly fixed on 2024 for the next rate hike. How things have changed thanks to an economy that is continuing to grow strongly and inflation running hot. However we look at this, tapering is widely accepted and expected now. Its unlikely that the Fed will be able to surpise the market in the coming months. Indeed, the rather muted reaction in the FX market to the FOMC statement signalled that a slightly more hawkish message was largely priced in.