You couldn’t fault Wall Street for envisaging a bit of Hamlet in Jerome Powell at the Federal Open Market Committee’s June policy meeting this coming week:
Transitory, or not transitory?
Therein lies the question that the interest rate-setting Fed committee needs to answer for financial markets next Wednesday, at the conclusion of the FOMC’s two-day gathering.
Whether ’tis nobler in the mind to suffer the slings and arrows of outrageous inflation or to take arms against a sea of troubles, as Hamlet might have said if he had been a central bank governor.
Of course, no one is expecting fireworks at this coming meeting but it could still proof a pivotal point for stocks and bonds.
The Fed meeting comes against the backdrop of growing evidence of pricing pressures building in the economy as it recovers from the COVID pandemic of the past year and vaccination rollouts allow businesses to return to some semblance of normality.
Last Thursday’s consumer-price index report from the U.S. Labor Department showed that the cost of living surged in May and drove the pace of inflation to a 13-year high of 5%, reflecting a broad increase in prices confronting Americans.
“The critical question now is whether this elevated rate of inflation is ‘transitory’ or whether higher prices risk becoming psychologically entrenched,” wrote Matt Weller, global head of market research at Forex.com in a Friday research note.
The fixed-income market may already have had its say on inflation, with the yields on the 10-year Treasury note BX:TMUBMUSD10Y and the 30-year Treasury bond BX:TMUBMUSD10Y hanging around their lowest levels since at least early March.
Treasury and stock-market investors are viewing the surge in inflation as fostered by supply chain distortions as consumers splurge after the pandemic, along with statistical base effects as last year’s falling prices drop out of the annual calculations, and therefore likely to be fleeting.
Is isn’t clear exactly however what transitory means — months, years ? How long are elevated levels of inflation to be tolerated before market participants and the Fed lose patience with inflation that undermines asset prices ?
“Going forward to the end of 2021 and into 2022, policy makers continue to expect inflation to subside back down nearer their 2% objective, is a message the Committee is likely to reiterate at next week’s meeting,” wrote Lindsey Piegza, chief economist at Stifel in a Friday note.
“That being said, the U.S. economy is clearly gaining momentum, with the labor market adding more than 500,000 jobs a month. Therefore, while no policy adjustment is expected in June, nor an announcement of a timeline for an eventual adjustment to policy, at least some Fed members are expected to push for a discussion in the coming months regarding an eventual rollback of emergency measures,” she said.
Some traders, analysts and economists are betting the Fed will aim to articulate the view that the tapering of its $120 billion a month purchase of assets, implemented during the worst of the pandemic, will begin by towards the end of 2021.
The Fed may talk about talking about tapering in June and by August or September begin the work toward a roll back.
In the face of rising inflation, the timing of any tapering looks tricky for the U.S. central bank since the recovery in the labor market still looks shaky, relative to the the demand for workers, and is reflected in the weaker-than-expected May nonfarm payrolls report and the job openings data from last week which hit a record 9.3 million.
Lawrence Gillum, fixed-income strategist for LPL Financial, said that the key thing the market wants to here is the timing of the Fed’s tapering. He also noted the tapering of the central bank’s $40 billion of mortgage-backed securities in particular will be important because the housing market is widely viewed as overheated.
“The main thing we’d like to hear next week is how and when the Fed plans to reduce its bond purchase programs,” Gillum said.
“Additionally, why the Fed continues to buy $40 billion in mortgage securities every month when the housing market, by all accounts, doesn’t need that support. Will we get that clarity? Probably not,” he offered.
Andrew Hunter, senior U.S. economist at Capital Economics, in a Friday report, said that in that context, he still expects policy makers to convey a go-slow approach to any scaling back of monetary accommodation.
“While we suspect that Fed officials may finally begin ‘talking about talking about’ tapering their asset purchases at next week’s FOMC meeting, they are likely to emphasize that the economy is still some way from making ‘substantial further progress’ towards their goals,” he said.
Indeed, Peter Essele, head of investment management for Commonwealth Financial Network said the market may need to hear more dovishness from Fed officials, even as they circumnavigate the notion of scaling back easy-money policies.
“Market participants are clearly expecting a dovish tone from the Fed next week, as evidenced by the recent path of interest rates,” Essele told MarketWatch in emailed comments.
“We expect the Fed will keep its foot on the accommodative pedal next week, which won’t change until inflation is no longer transitory and the economy is back to full employment,” Essele said.
“Until then, Treasury rates should remain range-bound on the long end and anchored on the short end, offering bond investors little to worry about in the near term,” he said.
What else is on investors’ radar?
Meanwhile, the only other main item on the docket for next week is U.S. May retail sales on Tuesday, while investors continue to watch negotiations between the Biden administration and Republicans on an infrastructure spending plan, given it has implications for economic growth and debt issuance.