Overview
What happened?
At the latest Fed meeting, the Federal Open Market Committee (FOMC) kept policy unchanged as expected. However, the latest dot plot showed that two more members now expect rate hikes in 2022 coupled with a stronger hike profile in 2023. In terms of economic projections, inflation expectations for 2021 were revised up sharply once again as the FOMC began to acknowledge the persistence of current inflationary dynamics. More importantly, Chair Powell confirmed the tapering signal given in August (with November as the expected start date) and added an expected wrap down time of mid-2022.
Our interpretation
The most important signal today was the confirmation of the taper by Chair Powell and the indicated taper pace of $15 billion per month. As a reference, during the last tapering round, it took the Fed one year to wrap down the programme. Relative to that pace, this is a double-quick taper, though still conditional on the recovery remaining intact. The hawkish shift in dot plots was more or less expected and can be seen as mark to market of higher inflationary concerns being expressed by a number of members, which was also visible in the rise in inflation projections.
Outlook
The hawkish taper timeline indicated by the Fed indicates to us a central bank getting sensitive to the sharp upswing in inflation. Although Chair Powell still blamed supply side issues as the major driver, the persistence in inflationary dynamics which we have been highlighting since Q1 are starting to create policy concern. The major risk here lies on the growth front where the momentum is starting to fade globally on the back of virus and supply side issues. If growth momentum fades faster than expected, slowing or reversing the pace of the recovery, then policy challenges for the Fed are likely to mount, especially if inflation remains sticky as we expect.
Asset allocation views
We maintain our neutral view on equities which we adopted a month ago after being long risk for most of the year. We still think the centre of gravity for yields is to the upside but our views on global growth are turning more negative, which produces two-way risk to our view. With the debt ceiling issue becoming significant in the coming weeks and the China risk factor kicking in, scope for increased volatility has risen across the board.
