On Wednesday, the minutes were released from the Federal Open Market Committee’s July session. They showed what many already assumed – that a growing number of Federal Reserve (Fed) officials believe tapering its asset purchases this year will be appropriate. The muted response throughout the U.S. Treasury curve shows the Fed’s communication strategy since the strong July jobs report prepared investors well for the shift in its forward guidance.
The Fed’s dual mandate – to foster price stability and maximum sustainable employment – presents a very difficult balancing act. Fed officials must keep inflation in check while remaining accommodative enough to support the labor market’s rehabilitation. The combination of burgeoning demand and disrupted supply chains is creating upward price pressures. While we expect to see inflation readings fall from their recent levels as supply challenges ease, current inflationary pressures will not vanish overnight. From a price perspective, it is clearly appropriate for the Fed to start winding down its asset purchases from its crisis-mode setting.
The employment side of the equation is less clear-cut. Millions of U.S. jobs have still not been replaced since the onset of the pandemic. The July jobs report showed meaningful progress toward closing the jobs gap, but the Fed would like to see a few more similarly robust reports before kicking off the tapering process. We expect payrolls to grow sufficiently over the next few months to allow the Fed to move toward a late 2021 taper. In the meantime, the Fed will use platforms like this week’s economic symposium in Jackson Hole to tee up its future policy shifts and limit chances of a market tantrum. Clear messaging and transparency will be key.
We also realigned taxable fixed income portfolios by reducing allocations to longer-term government bonds in favor of mortgage-backed securities.
A look back
- Last week, the S&P 500 fell 0.6% while the MSCI ACWI declined 1.8% on rising Delta variant concerns. Emerging markets tumbled 4.6%.
- The 2/10-year U.S. Treasury curve flattened 4 basis points to 1.03%. Investment grade and high yield credit spreads widened 3 and 4 basis points, respectively, in response to last week’s risk-off bias.
- Minutes from the Federal Open Market Committee’s July meeting showed a growing number of Fed officials are in favor of reducing asset purchases later this year instead of waiting until early 2022.
A look ahead
- Fed officials will use the Jackson Hole Economic Policy Symposium to publicly discuss its policy plans in an effort to avoid communication-related miscues. Chair Powell will speak Friday at 10am.
- The FDA approved the Pfizer-BioNTech two-shot vaccine on Monday morning. It becomes the first vaccine to move from emergency use authorization to full FDA approval.
- Economic releases: 2Q U.S. GDP, Markit U.S. Manufacturing, Personal Income/Spending, PCE inflation, Durable Goods Orders, and Home Sales
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