We expect the shockingly firm June CPI inflation report to have little, if any, consequence on the outcome of the July FOMC meeting. It will only influence a bond tapering announcement in the second half of this year to the extent that longer-term inflation expectations jump higher in response. We won’t begin to see the impact on the inflation expectations surveys until August. Therefore, the most likely outcome of the meeting this week will confirm our December announcement timeline for tapering.
Overall, there is no question that inflation has made the substantial progress necessary to warrant tapering bond purchases. Where there is more room for discussion is around what substantial progress means for the labor market. On this issue, there are two questions that need to be addressed.
- First, has maximum employment changed since the pandemic?
- And second, how small does the remaining “gap” between actual employment and maximum need to be before tapering is announced?
- FOMC members will also need to address a third question, which is even more subjective than assessing substantial further progress: When should the committee provide the so called “advanced notice” that a bond taper announcement is imminent?
We expect the FOMC to discuss three main issues this week.
- First will be a menu of options presented by the staff on how to wind down the purchase programs. This will include questions like “will the committee taper MBS first or faster than Treasuries?”.
- Second the FOMC will discuss the economic outcomes consistent with substantial progress.
- And third, the FOMC will need to decide when and how to provide the “advanced notice” that Powell has promised. Overall, we expect advance notice in September for a December announcement, but can’t rule out a scenario where the FOMC provides advanced notice at this meeting, signaling a September tapering announcement is likely. Seven FOMC members are currently projecting rate hikes beginning in 2022, and would likely prefer to taper sooner and faster than consensus currently expects. We don’t think Powell is one of them, but we can’t rule out a compromise with these members.
Bottom Line: All of these issues, plus the details of how the FOMC will wind down the purchase programs, will be discussed at the July meeting this week, and we would expect to get more details of those discussions from Powell during the press conference, and the meeting minutes that will be released in August. Overall, our base case continues to be for a December announcement of tapering both Treasury and MBS purchases, and for the programs to be wound down by August 2022.
Source: PIMCO, By Tiffany Wilding, US Economist at PIMCO