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Home News

Fed Tightening Policy: What You Need To Know

by Elaine Mendonça
June 17, 2021
in News
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Fed Tightening Policy

Source: Getty Images

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1 The FED “new” policies
2 The potential stock decline

The FED “new” policies

The Fed shocked investors on Wednesday by adding two interest rate increases in its 2023 economic projection after none of them had seen in their previous March projection. But it did not specify how long it would be until it starts cutting its bond purchases.

“You have a petroleum tanker. You must spin the wheel first, and then the ship begins to turn along the road. That’s what we have seen,” said Vincent Reinhart, Mellon’s top economist.

The Dow Jones Industrial Average fell 265.66 points, or about 0.8 percent, to 34,033.67. Treasury yields, which move in the opposite direction of price, rose. The 10-year yield has increased to nearly 1.58 percent, up from 1.48 percent earlier in the day.

Fed Chairman Jerome Powell stated that the central bank has had preliminary discussions about reducing its $120 billion monthly bond-buying program, as expected, but that the decision on when to begin reducing purchases is dependent on economic progress.

Economists anticipate that the Fed will make a more definitive announcement about the bond purchases at their annual Jackson Hole symposium in late August.

“They are reading the situation and trying to extract signs of policy firming from it. And so they can ride that,” Mellon’s Reinhart explained. “They can ride that by gradually tapering and emphasizing that tapering comes first, and they need to see more economic progress.”

There will be no repeat of the 2013 “taper tantrum.”

Reinhart noted that this is not the same as when former Fed Chairman Ben Bernanke surprised markets by announcing tapering in 2013, resulting in a market rout dubbed the “taper tantrum” years later.

This time, market experts expected the Fed to shift away from its accommodative stance.

While the Fed’s statement on Wednesday was viewed as hawkish, strategists say Powell managed to sound more dovish. “People are more concerned about inflation now, and he is playing to that by saying, ‘yes, it is higher than we thought, but it is transitory, and we have lots of tools to deal with it if it becomes a problem,’” Reinhart said.

He pointed out that while Fed officials raised their median forecast for inflation in 2021 by a percentage point to 3.4 percent for personal consumption expenditures inflation, they did not include higher inflation forecasts in their longer-term projections.

Fed Tightening Policy
Source: Getty Images

Inflationary pressures have become a source of concern for investors. In May, producer prices increased by 6.6 percent year on year, the highest rate in history. In May, consumer prices increased by 5%.

The tapering of Treasury and mortgage purchases, which is expected to take place over several months, is significant because it would be the Fed’s first step toward removing the easy policy it enacted to help the economy through the pandemic. It is also a sign that the Fed is preparing for the day when it will be able to raise interest rates, which is expected after the bond program is reduced to zero purchases.

During the press conference, Powell asked for the public’s patience. “We must be humble about our ability to comprehend the data. “This is not the time to draw hard conclusions about the labor market, inflation, or policy direction,” he said. “We need to see more data, and we need to be patient.”

Are you downplaying the dot plot?

Another comment from Powell, that the Fed’s so-called dot plot interest rate forecast isn’t all that important, was interpreted positively by market participants. This forecast is presented as a chart of anonymous dots representing each Fed official’s prediction of where interest rates will be in 2023.

“He downplayed the significance of the dot plot and so on,” said Ed Keon, QMA’s chief investment strategist. He stated that the Fed is gradually acclimating the market to the idea of tightening.

“I don’t think it’s good, but I also don’t think it’s the end of the world…

You appear to want the Fed to tighten. Stocks do not have to suffer as a result of Fed tightening. “The market can do just fine if the Fed tightens policy… and keeps inflation from spiraling out of control,” Keon said.

“When Fed policy is ineffective, it is negative,” he adds. “This will be a challenge for the Fed and the market in the coming years. There will be inflationary pressures, and no one knows whether they will be temporary or not.”

Keon stated that for the time being, he is bullish on stocks and will remain invested in the market.

“We are overweight stocks in our asset allocation portfolios and will remain so for the time being. We keep our eyes open, and if we become convinced that inflation will persist, I believe we will reconsider,” said Keon. “Your profits will increase by 40% this year.”

Despite the fact that no one knows whether inflation will continue to rise, he believes Powell’s approach is favorable.

“It demonstrates that the Fed is aware of rising inflationary pressures,” said Keon. “This gives you more confidence that the Fed is not stuck in this rut and that they will keep rates at zero and buy bonds until the economy becomes completely out of control.”

Powell, he said, did a good job of avoiding pitfalls during his press conference. “He handled the press conference exceptionally well,” said Keon. “It could have been a stretch to explain this minor change.”

According to NatWest’s Brian Daingerfield, the markets were concerned that the Fed would do more than it did.

“We are currently in an environment of strong growth and high inflation,” he said. “Clearly, the market expected a little more, and instead we got it in line. They’re edging closer to tapering.”

He said it’s a positive and a sign of strength that the Fed has scheduled two hikes for 2023, but Powell is emphasizing that the Fed views inflation as temporary.

The potential stock decline

The potential stock decline
Source: Getty Images

Most FOMC members expected rates to remain near zero until 2023, according to March projections.

Dot plot for the March meeting

If the dot shift occurred, the stock market would fall and face difficulties in the short term as traders digested the new stance, according to Siegel. But, as a long-term market bull, he doesn’t believe a scenario like the one he predicted would bring the bull market to an end.

“I believe we will see a short-term decline,” Siegel predicted. “I’m not calling it a taper tantrum; I’m calling it a taper tremor,” he added.

He explained that if the FOMC raises its expectations for a rate hike, the timeline for when the Fed begins to taper its asset-purchase program will likely be pushed forward as well.

“You can’t have a rate increase next year without first having a taper,” Siegel explained.

According to analysts most recent Fed survey, economists, fund managers, and Wall Street strategists do not expect tapering to begin before January or a rate hike until November 2022.

So far this year, Siegel, author of the well-known investing book “Stocks for the Long Run,” has maintained a bullish outlook on equities.

He did add a caveat to that forecast, saying he expected the Fed to become more cautious in the later stages of its tightening cycle.

“In a way, having a correction isn’t such a bad thing. It eliminates a lot of market excesses. “I don’t think the bull market is over,” Siegel said on Wednesday.

Siegel’s remarks came ahead of Fed Chairman Jerome Powell’s highly anticipated press conference, which is scheduled to begin at 2:30 p.m. ET.

Following its two-day June policy meeting, the central bank will release its policy statement and dot-plot projections at 2 p.m.

Wall Street is interested in how the Fed is interpreting a slew of data releases that show inflation is picking up across the United States as it recovers from the Covid pandemic.

Powell and other central bank officials have frequently stated that they believe rising prices are temporary and that, as a result, they believe that maintaining highly accommodative monetary policy is appropriate to help support a full labor-market recovery.

Tags: FED PoliciesFED StockStock market june 17
Elaine Mendonça

Elaine Mendonça

My focus is on uncovering early-stage ideas with the potential to have a lasting impact. My educational background includes a bachelor's degree in finance, an MBA, and two tests completed - the CFA and CMT. Over the last nine years, I have managed my investment portfolio using fundamental analysis and value investing, emphasizing long-term time horizons.

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