Fed Will String Traders Along on Its Taper Timeline

Want to know when the Federal Reserve will begin tapering its bond purchases? It seems easy enough: Just figure out what Chair Jerome Powell means by the word “string.”

“We want to see a string of months like that so we can really begin to show progress toward our goals,” Powell said earlier this month in response to a blockbuster March employment report. The word is generally defined as a sequence of similar events — in this case, monthly gains of a million jobs. San Francisco Fed President Mary Daly, reacting to the blowout March retail sales report, reiterated the need for “repeated months of this before we can distinguish optimism about the future from the realization of the future.”

Tim Duy, a former Bloomberg Opinion contributor who’s now chief U.S. economist at SGH Macro Advisors, quipped that he cringed a bit when he heard Powell say this, writing in a note:

“I saw where this could go. In a world where everyone is looking for clues about the tapering timeline, the definition of a ‘string’ is important. Is Powell sending a signal? Is he hinting at the timeline for tapering? Is it three reports? Or four? Or five? Is it few, several, or many? I can almost guarantee that financial journalists will start pressing Powell to define ‘string.’”

They’ll get their best chance to do so during Powell’s press conference after the Federal Open Market Committee’s decision on Wednesday. Adding to the intrigue around the Fed’s view on when it should reduce its $120 billion of monthly asset purchases, the Bank of Canada surprised markets with a hawkish tilt last week, announcing that it would cut purchases of federal government bonds to C$3 billion ($2.4 billion) a week from C$4 billion. Governor Tiff Macklem and other policy makers said the economy may recover from the Covid-19 pandemic sooner than expected, which could lead them to raise interest rates as soon as next year.

Don’t expect Powell to be cornered by the Bank of Canada or the press. The Fed chair has emerged from the coronavirus crisis with a new monetary-policy framework that focuses on outcomes over outlooks, helping him to stay on message and avoid any slipups. Perhaps most infamously, he suggested the central bank was “a long way from neutral” in October 2018, sparking a sharp drop in the stock market and forcing the Fed to abruptly lower interest rates less than a year later. All indications suggest he will kick off the conversation about achieving “substantial further progress” toward the bank’s labor market and inflation goals on his own terms.

Still, that brings Fed watchers back to the word “string.” As I noted in a column after March’s consumer price index data, May’s CPI will be released on June 10, less than a week before another FOMC decision. In all likelihood, headline inflation will be comfortably above 2% for the third consecutive month. Meanwhile, labor-market observers see a good chance of employers adding 1 million or more workers in each of the coming months. If two months is coincidence but three counts as “repeated,” that puts the central bank’s June meeting squarely in focus. Of course, policy makers also gather in July and September, while the Kansas City Fed’s Jackson Hole Economic Symposium takes place in August, so there’s always an excuse to delay the countdown.

A difference of a few months can make or break bond traders who are eager to start pricing in interest-rate increases. As it stands, overnight index swaps are factoring in about 18 basis points of a hike into the December 2022 Fed meeting, which is earlier than most policy makers expect. It’s worth a moment to work backward from that scenario. If that turns out to be the month of the first interest-rate boost, it stands to reason that the central bank would start scaling back its asset purchases well in advance — somewhere in the ballpark of 12 months before seems plausible. That, in turn, raises the question of just how much notice Powell and his colleagues want to give on tapering. Is three months enough (and thus they could wait until September)? Or do they prefer an even longer time frame (and therefore start the discussion sooner)? 

It’s doubtful that Powell will tip his hand this week, given that U.S. economic data has only just begun to pick up momentum and the U.S. Treasury market has calmed. But if the economy is as strong as many expect, he soon won’t have that luxury. This might very well be the last Fed decision in a while that he can get away with stringing bond traders along.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2021 Bloomberg L.P.

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