Initial market reaction to Fed’s tapering was pretty muted

November 3, 2021

Bruce Harris

Head of Global Fixed Income Strategy

SUMMARY

The dollar had little reaction to the Fed’s well anticipated tapering announcement. We believe the markets have priced in 2 to 3 rate hikes by end of 2022 and 4 to 5 hikes by end of 2023. It is indeed nearly impossible for the Fed to beat such hawkish expectations.

At the conclusion of their FOMC meetings on Wednesday (November 3), the Federal Reserve finally announced that it would begin its long-awaited (“tapering”) the $120bn of monetary accommodation it provides each month starting this month, by $10bn per month in Treasuries and $5bn per month in mortgage-backed securities. The Fed Funds rate was left unchanged at 0.00-0.25%.

At this pace, the Fed is likely to conclude the taper in June/July of 2022, though the Fed could adjust taper speed faster or slower depending on how the economy responds.

The Fed maintained its view on inflation, stating: “Inflation is elevated, largely related to factors that are expected to be transitory”, and added a line that – consistent with our view throughout 2021- clarified this point, saying “Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors”

In his press conference, Chairman Powell reiterated the Statement’s comments on inflation, stating that “the timing of a supply chain recovery is highly uncertain” and that Fed tools alone “cannot ease supply constraints”.

Initial Treasury market reaction was muted, with the 2y Treasury rate dropping slightly by 1pb to 46bps, the 5y flat at 1.19%, and the 10y and 30y steepening slightly by 3-4bps to 1.59% and 1.99%.

Immediately following the Statement release and ahead of Powell’s press conference, US equities rallied modestly after the central bank suggested that it views near-term supply chain pressures as temporary. During the Chair’s press conference, risk assets rallied more significantly, led by higher-beta segments like small caps and technology. Given minimal reaction in bond and currency markets, with near-term hawkish risk now out of the way, the post-FOMC equity move is largely a continuation of a strong month for performance amid a solid 3Q earnings season.

The dollar had little reaction to the Fed’s well anticipated tapering announcement. Markets have priced in 2-3 hikes by end of 2022 and 4-5 hikes by end of 2023 and it is indeed nearly impossible for the Fed to beat such hawkish expectations. Unless the Fed shifts to an even more hawkish stance which is quite unlikely given its view on the largely transitory nature of inflation, the already aggressive pricing of tightening means the dollar will likely stay range bound in the near term.

Global Fixed Income Strategy Bulletin (PDF 480.74 KB)

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