The Fed Should Consider Tapering at a Faster Pace, Insiders Say

The Fed Should Consider Tapering at a Faster Pace, Insiders Say

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A market in Vienna. Austria announced another lockdown and mandatory vaccinations as Covid-19 cases mount.

Joe Klamar/AFP/Getty Images

Winter is coming. A glance at the calendar attests to this, especially with the Thanksgiving holiday upon us, but that has been obscured in the Northeast by delightfully balmy temperatures. Now, however, the drop in the mercury is accompanied by a new rise in Covid-19 cases, both in Western Europe and the colder climes in the U.S.

Despite the potential damper on economies on both sides of the Atlantic from the resurgence of the virus, financial markets remained focused mainly on the Federal Reserve. As the wait for the White House’s decision on who will lead the central bank continues, other top Fed officials suggest that they should discuss speeding up the taper of the central bank’s securities purchases amid the current high inflation. That, in turn, could hasten the liftoff of the Fed’s policy interest rates next year.

Overseas Markets Data

Europe

Friday brought news that Austria had reimposed a lockdown to slow a rapid rise in infections, while neighboring Germany also faced lockdowns in some regions amid record daily cases, despite high vaccination levels.

Sharp increases also were seen in other Northern European countries such as the Netherlands, Denmark, Norway, and Finland. Given past patterns, in which European trends have led those of the U.S. by a few weeks, the latest jumps could be problematic. In the States, rises were seen in Vermont and New Hampshire, as well as Michigan, Minnesota, and Wisconsin, according to Bianco Research.

Markets reacted to the potential impact by bringing down oil prices and long-term bond yields, a reflection of the possible dampening effect on economic activity.

In the equity markets, European bourses dropped, while the tech-heavy Nasdaq ended at another record, but the other major U.S. averages flinched, with the more economically sensitive smaller-cap names giving ground.

Fed Vice Chairman Richard Clarida said on Friday that the “upside risk” to inflation should induce the Federal Open Market Committee to consider reducing its bond buying at a faster pace at its next meeting, on Dec. 14-15. The panel announced on Nov. 3 that it would trim its previous $120 billion monthly purchases of Treasury and agency mortgage-backed securities by $15 billion per month. Even at that slower clip, the Fed would still be adding another $420 billion to its $8 trillion balance sheet.

Moreover, the initial increase in the federal-funds target would have to await the completion of the Fed’s securities purchases, which wouldn’t be until mid-2022, according to this schedule. “I’ll be looking closely at the data that we get between now and the December meeting, and it may well be appropriate at that meeting to have a discussion about increasing the pace at which we’re reducing our balance sheet,” Clarida said.

It should be noted that his term at the Fed ends on Jan. 31. But Clarida was joined in his call for a faster taper by Fed Gov. Christopher Waller, who previously headed the research department at the St. Louis Fed. That bank’s president, James Bullard, has voiced similar sentiments, and will be a voting member of the FOMC in 2022. The St. Louis Fed historically has had an independent viewpoint in favor of sound money.

But the competition for the top spot at the central bank appears to revolve on other factors. Both Jerome Powell, the current leader, and Lael Brainard, the board member seen as the other candidate, endorse the Fed’s policy goals of maximum employment while allowing for temporary inflation overshoots. Their main differences appear to be on regulatory and other matters not associated previously with central banking.

Two Democratic senators, Sheldon Whitehouse of Rhode Island and Jeff Merkley of Oregon, wrote that they would oppose another term for Powell because he hadn’t been sufficiently vigilant about climate change. That’s despite the assessment by the Office of Financial Research’s recently released annual report that although “climate change has introduced vulnerabilities to the financial system, its potential risk to the financial system is difficult to identify, assess, and forecast.”

While the leadership of the Fed in the coming year remains in question, the futures markets expect the fed-funds rate to come off the current 0%-0.25% floor, starting in mid-2022. According to the CME’s FedWatch tool, there is a 65% chance of the first quarter-point hike taking place at the June 15 FOMC confab.

The perception is that Brainard may proceed more slowly in beginning to normalize monetary policy. But inflation, which has already proved more persistent than transitory, may be more important than personalities.

Read more Up and Down Wall Street: Why Bonds Look Like a Bad Bet

Write to Randall W. Forsyth at randall.forsyth@barrons.com

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