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January 29, 2024
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Financial Industry Insights from Advisors Asset Management
On July 29, 2021
The FOMC’s Tug of War
In addition to spotlighting the world’s greatest athletes, the Olympics often bring attention to obscure sports. Until 1920, the childhood classic rope game ‘tug of war’ was an Olympic competition. Today’s Olympics may not feature it, but the current Federal Reserve is fighting it.
A divided FOMC: hawks versus doves
One side of the Federal Open Market Committee (FOMC) is relatively dovish. This contingent comprises Fed Chair Powell, Lael Brainard and Richard Clarida. The other side, comprising regional Presidents Jim Bullard, Robert S. Kaplan, and Patrick T. Harker, is much more hawkish.
Our bias is to back the side with Chair Powell, whose influence is akin to having Dwayne ‘The Rock’ Johnson pulling rope on the team.
Today, the doves asserted their control as the Fed kept its statement largely unchanged and avoided offering formal guidance on tapering, underlining that while the committee is data dependent, it is also patient.
Delta variant adds to the doves’ case
The spread of the contagious delta variant has strengthened their argument, by exacerbating downside risks to the recovery. Although the vaccine rollout has dramatically reduced the probability of renewed large-scale restrictions, the variant has the potential to, at least partially, slow down the recovery perhaps a result of consumers voluntarily retrenching.
Ultimately, it makes the reason to begin withdrawing policy accommodation less compelling. Further, although the absolute pace of growth remains strong, economic activity has gone from consistently and substantially outperforming expectations, to slowing to consensus levels (Figure 1).
Figure 1: Economic data continues to be strong, but is no longer outperforming expectations
Source: Citi, July 2021
We could even be at peak growth as a gross domestic product (GDP) growth rate of 8% to 10% is clearly unsustainable over the long run in the US. A gradual slowing is to be expected as the output gap narrows, adding further justification for policy caution.
No taper talk yet
The Fed made no formal communications around ‘tapering’ its asset purchases. While recognizing progress has been made since the start of the year, its statement retained the reference to “substantial further progress” being required before tapering could begin. Powell also noted the labor market is “some ways away” from hitting that benchmark, a dovish line in the sand.
As such, we continue to expect ‘taper talk’ at the Jackson Hole event in August. We see it as the ideal opportunity for Chairman Powell to lay out the Fed’s thinking and set the parameters of discussion on tapering, including whether to taper mortgage-backed securities (MBS) purchases faster than Treasury purchases.
Alongside today’s policy announcement, the Fed announced a long-awaited standing repo facility to help ensure smooth functioning of money and Treasury markets. However, we do not view this announcement as impacting future monetary policy.
More tug of war rounds to come
The policy debate is far from over. We expect substantial further progress in the labor markets over the next few months, bringing unemployment down towards 4% to 4.5% by year-end. This may meet the Fed’s threshold to begin tapering.
As things stand, we believe tapering looks like a 2022 story, with the first rate hike potentially to follow in 2023.
The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit http://www.aamlive.com/.
Please note: any forecasts or opinions expressed herein are Insight Investment's own as of July 28, 2021 and subject to change without notice. Information herein may contain, include or is based upon forward-looking statements within the meaning of the federal securities laws, specifically Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include all statements, other than statements of historical fact, that address future activities, events or developments, including without limitation, business or investment strategy or measures to implement strategy, competitive strengths, goals expansion and growth of our business, plans, prospects and references to future or success. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Words such as ‘anticipate,’ ‘estimate,’ ‘expect,’ ‘project,’ ‘intend,’ ‘plan,’ ‘believe,’ and other similar words are intended to identify these forward-looking statements. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining our actual future results or outcomes. Consequently, no forward-looking statement can be guaranteed. Actual results or outcomes may vary materially. Given these uncertainties, you should not place undue reliance on these forward-looking statements.
CRN: 2021-0713-9305
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