Market Extra: Federal Reserve seen more ‘hawkish’ as Powell tees up tapering, but the market signals economic growth concerns


Investors were ready for the Federal Reserve to tee up a possible announcement of a tapering of its bond purchases in November in its policy statement Wednesday, but a slowing economic recovery could mire more hawkish monetary policy steps.

The prospect of the Fed this year beginning to slow its monthly bond purchases, with an eye toward gradually ending them by mid-2022, doesn’t worry Daniela Mardarovici, co-head of U.S. multisector fixed income at Macquarie Asset Management. That’s a “sigh of relief” as the market no longer needs that accommodation and the Fed has been carefully messaging its intention to taper for some time, she told MarketWatch in an interview.

But Mardarovici sees the market questioning the Fed’s ability to raise interest rates, despite it appearing more “hawkish” following its policy meeting Wednesday, with central bankers projecting a possible rate hike next year, she said.

“The most important piece of this puzzle is that longer-term rates are actually lower since June,” a sign the market believes the economy may not be strong enough for the Fed to hike “in any shape or form,” said Mardarovici. Longer-term yields moved slightly down while short-term rates edged up Wednesday as the market digested details from the Fed meeting, she explained, in an “almost imperceptible” flattening of the yield curve. 

Slowing economic growth combined with rising inflation could put the Fed in a “conundrum,” according to Mardarovici. While the Fed could tame inflation by raising rates, doing so too quickly risks hurting the economic recovery.

Some investors worry the increased pace of inflation in the pandemic may stick around longer than expected, with market analysts pointing to pressures building from supply-chain disruptions as well as labor market shortages. Limited supply is being met by elevated consumer demand for goods, as people have spent less on services amid fear over COVID-19.

“The reality of the situation is that we’re still beholden to the trajectory of the virus,” said David Lebovitz, global market strategist at JPMorgan Chase & Co.’ s asset management unit, in a phone interview. “There are going to be knock-on effects when it comes to the supply chain globally.”

While lingering supply-chain problems may add to inflationary pressures for longer than people may expect, Lebovitz said that higher costs should still prove transitory. That’s because rising inflation is a cyclical element of the pandemic rather than a structural concern, he explained.

Read: Hawks rule the roost at Fed, economists say

Although the Fed appeared “a little bit more hawkish than expected” after its meeting this week, it came as no surprise that it’s moving towards taper, and markets were “already priced for a first hike in December of ‘22,” according to remarks made by John Bellows, a portfolio manager at Western Asset, during a fixed-income markets panel at the Morningstar Investment Conference Wednesday.

But “they’re moving ahead with this taper program in the context of a pretty material downgrade to growth,” Bellows said. Against the backdrop of this risk, he said “10-year yields and 30-year yields were actually lower” Wednesday.

On Thursday morning, the yield on the 10-year Treasury note

was trading almost 7 basis points higher at around 1.38%. That’s still below a yield of about 1.44% at the end of June, according to Dow Jones Market Data.

The “reality of peak growth happening in the second quarter is setting in,” said Bellows, suggesting that lower retail sales since April are behind expectations for slower growth in the third quarter.

Meanwhile new surveys of the economy show the U.S. is still expanding at a rapid pace, though labor and supply shortages remain a drag on growth, MarketWatch reported Thursday.

See: The U.S. economy is still plowing ahead despite delta, new surveys show

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