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The Federal Reserve is on track to signal a QE taper as soon as next month and start scaling back the program in November, with recent strong job creation more compelling than concerns the Delta variant will soon slow hiring again, current and former advisers tell MNI.
Policymakers appear to be placing less weight on factors they had emphasized earlier -- the need for a more fulsome rebound in workforce participation and the employment-to-population ratio -- and shifted focus to upside surprises on inflation and concerns those price gains might linger.
"If inflation remains high and now it is getting more difficult to argue that the labor market is weak, then tapering should happen relatively sooner," said Dean Croushore, a former long-time economist at the Philadelphia Fed. "Tapering is even more likely if break-even inflation measures start moving higher, as the Fed certainly doesn't want to lose its anchor on long-term expectations." (See MNI: Fed Inflation View Tested By Hot Streak, Ex-Officials Say)
A larger-than-expected gain of 943,000 jobs in June, in addition to upward revisions and broad signs of strength, cemented expectations the Fed needs just one or two more strong prints before declaring its criteria of "substantial further progress" has been achieved, the trigger for reducing the USD120 billion monthly bond buying program.
"If the inflation numbers continue to be high, I would not be surprised to see a tapering announcement at the next meeting, with tapering beginning as early as October," Croushore said.
LOWERING THE BAR
Even before the jobs report, a string of inflation readings around 4% to 5% strengthened the case of those like St. Louis Fed President James Bullard who say the Fed needs to start tapering as early as September and conclude asset purchases in as little as six months so as not to fall behind the curve if it needs to raise rates next year.
The Fed has previously hailed the employment-to-population ratio as a new lodestar for jobs progress because it encompasses workforce participation, which is still severely depressed compared to pre-Covid levels. But between December -- when the Fed announced its "substantial further progress" bar -- and July, EPOP has recovered 1 pp, just a quarter of the way back to its pre-pandemic level.
The economy needs to add roughly 2.3 million more jobs to reach the halfway progress mark, but fresh concerns about fast-rising infections tied to the Delta variant could see the recovery pace ebb.
"The taper itself could hit just as we see a fall in the employment-to-population ratio and a fall in the participation rate," said Danny Blanchflower, an ex-Bank of England member who was also formerly a visiting scholar at the Boston Fed.
"All the risks have to be to the downside," he said, citing the uncertain path of vaccination rates, long-run changes in behavior and zombie firms.
Growing worries about the severity of Delta have spurred vaccinations in recent weeks, which will help ease people's fear of getting infected if they go back to work. But that will also take time to play out, Fed advisers said.
Diane Swonk, an economist who advises the Fed's board of governors in Washington and the Chicago Fed, agrees with Croushore that a taper announcement could come as early as September -- and definitely before year end.
But the timing of an eventual rate hike will be determined by deeper progress in indicators like EPOP and participation, which may be affected by the Delta variant. "The risk of permanent scarring goes on the longer this goes on," Swonk said in an interview.
"I'm sure a lot more workers will be looking for a job, but a lot of these workers are not vaccinated and it takes at least five or six weeks to get vaccinated," she said. "And even if you're vaccinated, we now have got a different risk level by being in congregate settings than we did before."
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