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The FOMC this week is expected to cheer steady progress in the Covid-19 recovery but maintain that it will still take some time before the economy meets the Fed's "substantial further progress" bar for tapering asset purchases.
Officials will likely talk about stepping back QE but give no new guidance or refinement of the "substantial further progress" standard. Policymakers have also said the debate over the taper will take several meetings.
The Fed is wary of detailed on-the-record discussions on tapering because such talks have the potential to trigger volatility in financial markets and a tightening effect on the trajectory of the real economy, former officials told MNI.
Chair Jay Powell will likely also downplay any additional projections for liftoff by the end of 2023, former officials told MNI. If two or more policymakers upgrade their forecasts, it is possible the median projection for the Fed's first post-pandemic interest rate hike will move forward into 2023.
With the Fed's emphasis on outcome-based policymaking, the FOMC will need to evaluate the economy's progress against its objectives. Since March, projections for growth and inflation are likely to get a small upgrade, while the outlook for the labor market may be little changed after three months of inconsistent data.
Even with two months of record-setting inflation data, officials are unlikely to have changed their view that the price spikes are transitory and associated with the reopening of the economy. Former officials still saw ample room for medium-term inflation expectations to rise after a decade of downside misses, but they also warned the Fed's perceived indifference to faster inflation may send price expectations lurching higher than policymakers want and force a messy rethink of their stance.
JOB MARKET AMBIGUITY
Payrolls were strong, weak and lukewarm over March, April and May, respectively, creating ambiguity over hiring momentum. On average, the economy added 540,000 jobs a month in the past three months, below the pace that would close the employment gap and see participation recovering substantially by year-end. At the current rate, the labor market is only expected to reach pre-pandemic levels by the end of 2022.
Former policymakers told MNI the Fed won't see enough clear labor market improvement in time to announce tapering of QE at the annual Kansas City Fed Symposium at the end of the summer.
If hiring still doesn't pick up after September, when supplemental job insurance runs out and kids return to school, the road to rebuilding employment might be rockier than previously thought, a Richmond Fed economist told MNI.
The Fed is likely to abstain from raising rates paid on reverse repos or excess reserves despite potential financial stability risks stemming from money market funds and as short-term market rates fall.
Former Fed Board division of monetary affairs chief Vincent Reinhart told MNI the Fed could offer money funds relief by raising the rate it pays on reverse repo operations or the rate paid on reserves but the central bank is likely leery of bailing out the industry for the second time in a dozen years.
The officials are only likely to move if negotiations over the U.S. debt limit drag on into the fall, current and former officials told MNI last month.