Challenging Week Ahead

A robust employment report would mean the earliest window for the Fed to signal its intention on the pace and composition of its bond-buying would be the Jackson Hole conference at the end of August. By the time the Fed meets in September, there will be another employment report, and there may be more clarity about the impact of the growing virus. Fed Chair Powell has pledged an advanced warning to the market about its decision about tapering.

The hawk camp wants to taper, and some want to focus on the MBS purchases, and the sooner, the better. The dove camp is in no hurry and seems somewhat less convinced that those purchases drive up house prices, which have continued to soar at a record pace according to the S&P CoreLogic Case-Shiller 20-city 17% year-over-year in May. The FHFA house price index has risen by more than 1% a month since June 2020. It is more than twice the pace that it had averaged in 2016-2019. 

In practical terms, the hawks seem to prefer tapering later this year, which if this window is going to remain open, some clearer guidance needs to be provided soon (September). The doves may be more inclined to start the actual tapering next year, clear of the debt ceiling issue, and have a better understanding of the sustainability of price pressures and after income support programs expire.

Tactically, with note and bond yields at several month lows and record-low real rates, some officials see these conditions as ideal to announce its intention to taper in the coming months. The market has provided a cushion for an exaggerated reaction that cannot be ruled out.

For long-term investors and corporate Treasurers, it might not be a big difference between tapering late 2021 or early 2022. However, many will extrapolate from slowly taking a foot off the accelerator to tapping on the brake. The December 2022 Eurodollar futures contract implies a three-month yield in 16 months of about 40 bps. The current three-month rate is about 13 bps. That implies a 25 bps hike is anticipated. Recall that a significant minority of Fed officials (7/18) anticipated in June that a hike by the end of next year would be appropriate.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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