The Federal Reserve has recently announced that it will maintain the benchmark interest rate unchanged at 0%-0.25%, in line with market expectations. The Fed has pledged to continue its asset purchase program at least at the current pace of USD 120 billion per month until employment and price stability goals make substantial progress. Fed Chair Jerome Powell stated that if current trends continue, the Fed may soon be able to reduce the size of its debt purchases. The Fed will gradually reduce its debt purchases, which will end around the middle of 2022. From this point of view, the Fed has already begun preparations to tighten the easing, and it may start within this year.
At the same time, market participants are also expecting the prospect of future interest rate hikes to be earlier than previously estimated. The latest dot matrix chart released by the Fed shows that 9 FOMC members are expected to raise interest rates for the first time in 2022. In summary, 7 members support rate hikes, while the number of members who believe a delay in interest rates should extend until 2023 is 17, which is 4 more members than in June. The Fed may tighten monetary policy sooner than predicted as a result of strong inflation and market stability, as seen by this meeting. However, unlike the scenario of the start of easing, the Fed will face more challenges and troubles withdrawing from the easing policy, and this process will be full of uncertainty.
The information released by the Fed meeting reflects the Fed's cautious attitude on plans to withdraw from the stimulus policy. Judging from the current economic recovery in the United States, it seems that the problem is not so simple. The prerequisite for the Fed's reduction of easing is "continuous progress" in employment recovery. At the same time, the Fed also emphasized that even if the reduction is initiated, once the situation recurs, it is still possible to restore the scale of QE. As a result, while the Fed has indicated that it may begin the reduction, when and how much it will reduce is dependent on the U.S. economy's recovery and changes in inflation. Needless to say, there are still many uncertainties ahead.
Most Fed officials now believe that the core inflation rate will rise from 3% predicted in June to 3.7% at the end of this year. Officials foresee that the inflation rate will slow to 2.3% in 2022, compared to a 2.1% estimate in June; it will slow to 2.2% in 2023, compared with 2.1% in June's forecast. Due to the continuous spread of the Delta variant of the novel coronavirus and the distortion of the global supply chain, the Fed has lowered its economic growth forecast. It currently predicts that U.S. GDP will grow by 5.9% this year, lower than the 7% predicted in June. They expect the unemployment rate to remain around 4.8% in the fourth quarter, higher than the 4.5% forecast in June. This change has reduced the possibility of the Fed's reduction of easing. With high inflation levels, the Fed has always emphasized the preconditions for the adjustment of monetary policy due to employment and economic recovery. In the context of slowing economic growth, why did it propose the prospect of reducing easing? Is it because its employment target has been achieved? This reason may be difficult to establish. Therefore, there is the suspicion that the Fed is more worried about the emergence of a future "stagflation" scenario, which may not be an optimistic signal for the U.S. economy.
If the U.S. economy recovers less than expected and inflation continues to remain high, the Fed's future policy choices will be even more uncertain. At present, the separation of inflation and employment has caused divergence in views and policy choices on the prospects of the U.S. economy. The Fed can only rely on the thought that inflation is temporary to maintain its current easing policy to achieve its monetary policy goals. Whether this reason can be established or not depends on how long the current "high inflation" can last. If inflation falls in the first quarter of next year, the Fed's urgency to end easing will be greatly reduced.
As a result of the pandemic, employment and inflation have grown more structural, reflecting fundamental challenges in the U.S. economy, while the use of monetary policy to support economic recovery has also proven challenging. Therefore, the biggest uncertain factor for the Fed is still the pandemic. COVID-19 not only has an impact on consumption and employment but has also messed up the supply chain. These factors may not be able to be brought under full control in the short term. This is probably the main factor that makes it difficult for the Fed to reduce easing with clear expectations.
Following years of monetary easing, the imbalance in the U.S. economy has become more visible, and the impact of the pandemic has made this differentiation more prominent than ever. In this case, the role and effect of monetary policy are declining, and its role is more reflected in changes in asset prices. With the continuous expansion of the U.S. capital market, it is increasingly difficult to withstand the reduction in liquidity and the increase in interest rates. With the Fed becoming more and more swayed by the capital market, whether it can smoothly withdraw from the easing is still a major challenge. Even if the Fed could start the reduction as scheduled, the process will be relatively long, and the cycle might repeat itself. As far as the Fed is concerned, whether it can start to withdraw from the loose policy as scheduled and achieve the normalization of monetary policy is still full of challenges.
Final analysis conclusion:
Although the Fed has proposed the prospect of reducing the easing policy, it is still full of uncertainties in achieving such a process. It depends not only on changes in the U.S. economy but also on changes in the capital market. For the realization of this process, the market needs to be more cautious.
