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MNI (Washington)

The Federal Reserve could wait longer than investors expect to begin reducing its QE program if gains in the employment-to-population ratio fail to pick up appreciably at the end of summer, New York Fed economic adviser Sebnem Kalemli-Ozcan told MNI.

"They are really focusing on the dual mandate here, they are really focused on the employment side and these kind of past experiences I think taught them that it's not that straightforward when you see inflation picking up a little bit that you're going to get back to full employment," Kalemli-Ozcan, an economics professor at the University of Maryland and a member of the New York Fed's economic advisory panel, said in an interview.

Wall Street believes the Fed will start slowing its monthly USD120 purchases of Treasury and mortgage bonds at the end of this year or early next year. But that scenario is contingent on the prospect that a recovery in employment and the size of the workforce, which have so far disappointed, will pick up appreciably after schools reopen in September and comfort with vaccination levels becomes more widespread.

The economy did generate a robust 850,000 new jobs in June, but the employment-to-population ratio, a key metric for Fed officials, did not budge from 58.0%, far short of a pre-crisis reading of 61.1%.

"The labor market is not fully back so the Fed will wait for that," Kalemli-Ozcan said after the report on Friday. "There are some structural changes going on that we do not fully understand," she added, pointing to the puzzle of a large number of open positions alongside reports of employers who can't find enough workers to hire.

Richmond Fed President Thomas Barkin told MNI in a webcast last week he would like to see further increases in the employment-to-population ratio before he can declare "substantial further progress" toward the Fed's full employment goal, an FOMC-designated prerequisite for tapering QE.


Kalemli-Ozcan said policymakers scarred by the experience of the 2013 taper tantrum are all too aware of the possibility of an adverse market reaction when the Fed does start reducing its bond buys, and will thus approach the process very gradually.

"If they are going to start changing this USD120 billion monthly purchases they are really going to clearly communicate that. This is the lesson from the May 2013 taper tantrum -- they are not going to make that mistake again," she said. "This is going to be slow."

Fed Chairman Jerome Powell's press conference this month provided a mini test run for the market's capacity to absorb hawkish surprises. He was forced to both deflect market concern about a moving forward of the Fed's own expectations for the timing of rate hikes as well as conceding policymakers have started "talking about talking about" the tapering process.

The level of caution embedded in Powell's language choice was itself a signal of just how deeply the Fed's desire to start tapering bond buys is conditional on robust additional employment gains.

"There are not going to be any surprises. A surprise in that would have even bigger ramifications than when interest rate liftoff is going to be because that is something that really helps to decrease risk spreads."

Powell largely passed his initial test as an early decline in equity prices and higher bond yields quickly reversed course but it remains to be seen how investors will react to actual news that a taper is imminent.


Kalemli-Ozcan pushed back against recent concerns about a persistent spike in inflation due to a combination of strong monetary support and a proactive fiscal policy.

The worries were exacerbated by higher-than-expected readings, with the year-over-year consumer price index hitting 5% in May and the Fed's preferred PCE index rising 3.9%. Most Fed officials believe that number is likely to come down fairly quickly as post-Covid price adjustments subside, and Kalemli-Ozcan agrees.

"I am with Chairman Powell on this. I'm in the camp that this is going to be transitory," she said.

"This was not a financial crisis, it was a health shock and it affected sectors differently. So If we could not get to full employment with the previous shocks which were more straightforward, why do we think we'll immediately get to full employment now? It's going to take time."

To her point, Fed officials and market participants have curbed expectations for monthly employment gains down from 1 million or more earlier this year to around 500,000. The Labor Department will release the June jobs report Friday.

Kalemli-Ozcan said the Fed will likely try to finish the tapering process before it begins raising interest rates, a topic that's gaining increasing scrutiny.

"If they do end up doing these things at the same time -- hiking rates and tapering -- that is not going to be taken well by the markets for sure. But I don't believe they are going to do that," she said. "If markets start pricing in this expectation I think the Fed is going to be very clear in their communication that they are going to partition these things out and not do these things at the same time."

MNI Washington Bureau | +1 202-371-2121 |