MNI STATE OF PLAY: Fed To Advance Tapering Debate At July Meet

Investors will watch Fed Chair Jerome Powell's press conference Wednesday for evolving assessments on inflation and labor market progress, as officials continue to hash out how and when to wind down asset purchases.

Since they last met in June, officials likely pushed up their inflation forecasts further after CPI surprised to the upside last month, rising 5.4% from a year earlier. But views differ over how transitory supply-side disruptions will prove.

No announcement on tapering is expected at this week's meeting, and there will be no update of officials' economic projections and the rate hike timeline

The core of the FOMC maintains that the recent jump in prices is tied to the reopening of the economy and that inflation will return to 2% next year, urging patience on tightening. The proliferation of the Delta variant of Covid-19 in recent weeks, adding to downside risks for growth, reinforces their case.

MISSING JOBS

Some more hawkish officials however see a risk of the current spike in prices lasting through next year. They call for a rate hike next year and an earlier start to tapering.

Policymakers have promised to maintain USD120 billion of monthly Treasury and mortgage bond purchases "until substantial further progress has been made toward the Committee's maximum employment and price stability goals."

Many view the economy as having met the guidance threshold on prices but disagree on labor market progress and how difficult it will be to get people back to work. Some see substantial slack stemming from the roughly seven million jobs still missing from the economy while others believe the labor market is already tight and set to stay that way.

Powell in testimony to lawmakers earlier this month warned of risks in overreacting to temporary inflation when the "true" unemployment rate is "substantially above" the official rate of 5.9%.

However, to the extent that a high rate of price increases persists, threatening the stability of inflation expectations at 2%, Powell pledged to act. The FOMC stands ready to adjust policy if it "saw signs that the path of inflation or longer-term inflation expectations were moving materially and persistently beyond levels consistent with our goal," he said.

TAPER DETAILS

FOMC members also judged in their June meeting that "as a matter of prudent planning, it was important to be well positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments, including faster-than-anticipated progress toward the Committee's goals or the emergence of risks that could impede the attainment of the Committee's goals."

The timing and form of the taper have yet to be decided and communicated. Former Fed officials told MNI the Fed is probably looking at winding down its bond purchase program over 12 months, but could take a flexible approach as conditions change, with some officials lobbying for a faster reduction of mortgage bonds and some for a more rapid taper overall.

Powell told lawmakers this month that low interest rates and purchases of Treasuries and mortgage-backed securities were all contributing to the strength of the housing market, with MBS "contributing probably a little more than Treasury securities, but ultimately, it's roughly the same order of magnitude."