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Thursday, November 04, 2021
Fed's Scaling Back on Easing and Its Implications
ANBOUND

On November 3, the Federal Reserve announced a new monetary policy statement after the two-day interest rate meeting was concluded. As expected by the market, the Fed will reduce its monthly bond purchases starting this month to reduce its stimulus to the market. The Fed will continue to maintain the current interest rate 0% - 0.25%. At the same time, the plan will be launched in November to reduce the size of monthly asset purchases by USD 15 billion, and it is prepared to adjust the pace of reducing the scale of bond purchases when necessary. The Federal Open Market Committee (FMOC) stated that the move was because of the further substantial progress the economy has made towards the committee’s goals since December last year.

Both maintaining interest rates unchanged and the reduction of easing are within market expectations. As early as after the Fed's meeting on interest rates in September, Fed Chairman Jerome Powell revealed that tapering may be announced at the next meeting as soon as possible. He also mentioned that it is appropriate to gradually reduce quantitative easing (QE) and end it around mid-2022. There is basically no strong reaction from the capital market after the announcement of the resolution. U.S. stocks continued to rise, while the U.S. dollar remained basically stable. U.S. bond yields rose slightly, indicating that the capital market has fully digested the relevant policy changes.

This indicates that the Fed's monetary policy has begun to shift, although it has not yet stopped easing. Based on the current progress, until the middle of next year, the Fed will completely end QE and stop injecting liquidity into the market. Therefore, in the next eight months, the Fed will not truly stop easing, but the rate of injection of U.S. dollars will gradually slow down. Analysts at JPMorgan Asset Management reminded that reducing bond purchases does not indicate monetary contraction. It also stated that the Fed's balance sheet will continue to increase by around USD 400 billion over the following eight months, underlining that easing will not end quickly and that the market's rather calm reaction.

While scaling back on easing, the Fed emphasized that the present high inflation rate in the U.S. is only transitory, however, Fed Chairman Powell noted that he is unsure when the supply chain disruption issue will be resolved.

He said it is hard to predict the impact of continuous supply chain disruptions on inflation. He noted that the global supply chain is complex, and the problem of supply chain disruptions in the future will definitely be resolved, but there is uncertainty in timing. There is still a lot of debate regarding the Fed's position, and many people are concerned about the Fed's ability to grasp the issue of inflation. The difficulty for central banks, including the Fed, lies in judging whether this inflation is temporary or more structural. Many are also worried that the current development of inflation will bring irreversible consequences before the Fed changes its mind. There are still many uncertainties in this regard.

Regarding the market’s current interest rate hike prospects, Powell also said that now is not the time to raise the benchmark interest rate, and that the Fed will use its tools to control inflation when appropriate. The FOMC statement says the committee has decided to maintain the target range of the federal funds rate at 0-0.25%, and expects that the labor market will reach the highest employment rate and inflation rate that the committee has set. The statement added that it is appropriate to maintain this target range before assessing the consistent level and expecting to slightly exceed 2% for some time. For the market, Powell's statements continue to send out a "dovish" signal.

ANBOUND has previously mentioned that the Fed still hopes to use quantitative tools to adjust currency liquidity and adopts a more cautious approach to the use of interest rate tools. The Fed's monetary policy adjustment is still carried out in accordance with this line of thinking. However, the market has already begun to expect the Fed to start raising interest rates in June or September next year to cope with the threat of possible high inflation. Nevertheless, according to the current pace of easing reduction, raising interest rates in June next year will be a bit hasty unless inflation becomes uncontrollable. This divergence should stem from different expectations for inflation. However, as Powell said, he does not want the central bank's decision to bring too many "surprises", thereby triggering market volatility.

In particular, judging from the changes in the Fed's monetary policy this year, there is a worrying sign that the Fed's policy has lagged behind the market, which creates doubts about the Fed's ability to grasp economic trends and the effect of monetary policy. In fact, the market has foreseen that inflation will change faster and may last longer. Whether it is the Fed's scaling down on easing or a likely future interest rate hike, it may lag in the wake of changes in the situation. Of course, another factor is the prospects for the recovery of the U.S. economy. Judging from the situation in the third quarter, the U.S. economy has already shown signs of slowing down. This may be a concern for the Fed to adopt a conservative approach. This also reflects that the current Fed's monetary policy is losing its impact on the economy, and the economic trend is affecting the Fed's policy. This lack of expectations is also at the root of the market's growing concern about the risks posed by central bank policy.

According to ANBOUND researchers, if the Fed scales back its easing, the impact on the rest of the world will not be as severe as it was the last time. This has been reflected in the performance of emerging markets. Some countries have already started a policy shift, which has offset the effect to a certain extent. In addition, in the case of global lockdowns caused by the COVID-19 pandemic, the independence and differentiation of the economies of various countries could explain the reasons for the decline in the effect. At present, both the European and Japanese central banks have stated that they will not follow the Fed's pace and will still stick to their respective easing policies. The European and Japanese markets have also reacted fiercely to this. Of course, the cautiousness of the Fed has slowed down such an effect. The impact of the monetary policy shift will also be long-term. As the dollar's liquidity slows down, its global impact will still have the effect of a "boiling frog”, i.e., the inability to perceive greater danger. The market will then need to be vigilant to prepare for such consequences.

Final analysis conclusion:

The Federal Reserve’s scaling back on easing policy as scheduled was within market expectations. However, there are still many uncertainties regarding inflation and interest rate hikes. The reason for the Fed's cautious attitude is that it hopes to eliminate short-term fluctuations in the economy and capital markets caused by policy changes.

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