MNI STATE OF PLAY: Fed Signals Taper Closer If Job Gains Build

The Federal Reserve is one step closer to winding down its USD120 billion of monthly asset purchases and is waiting for continued job market improvement before pulling the trigger.

The U.S. economy is on track to grow at the fastest rate in decades and the Delta variant may only slow momentum for a few months as people have learned to live with Covid, Fed Chair Jay Powell told reporters Wednesday. Inflation is already running well above the Fed's 2% target, but that gain may be fleeting with the drag of eight million people still out of work.

"We're some way away from having substantial further progress toward the maximum employment goal," he said when asked about tapering after a two-day FOMC meet. "I would want to see some strong jobs numbers."

Having moved away from a singular metric for judging the labor market last year, the Fed is now watching a range of factors including unemployment among different age groups, participation, wages and labor market flows data, Powell said.

The job market still faces disruptions including fear of catching the virus at work, a lack of child care and generous unemployment benefits that will be phased out by September. "All of those factors should wane," Powell said. "Americans want to work, and they'll find their way into the jobs they want. It may take some time though."

INFLATION TO MODERATE

Worker shortages and other supply constraints as the economy re-opens raise the possibility that "inflation could turn out to be higher and more persistent than we expect," Powell said.

Inflation is running above 2% and expected to stay there for another few months before moderating, he said. The Fed's best guess is the economy will adapt to shortages as well as booming demand for cars, plane tickets and hotel rooms, taking average price gains back to target.

"In the near term, the risks to inflation are to the upside. Inflation will move back down, again it's hard to say when that will be," Powell said.

If inflation expectations move "materially and persistently" above 2%, "we will use our tools as appropriate over time" to make sure the Fed's goals are met, he said. "We won't have an extended period of high inflation."

TAPER, THEN HIKE

With maximum employment still a couple years away, raising interest rates is "not something that's on our radar screen right now," Powell said.

Fed officials considered ways of tapering asset purchases at this week's meeting. Though some favor reducing mortgage-backed securities buys at a faster pace than Treasuries, given the red hot housing market, Powell signaled the FOMC is unlikely to trim MBS earlier than Treasuries.

Former Fed officials also expect policy makers to model their plan on the QE3 taper, without special priority for MBS. (MNI: Fed Looking At 12-Month, Flexible Taper - Ex-Officials)

"Treasury and MBS purchases affect financial conditions in very similar ways. There may be modest differences in terms of contribution to housing prices, but it's not something that's big," Powell said.

The FOMC also prefers ending QE before raising interest rates, the Fed chair said. "Ideally you wouldn't be still buying assets and raising rates because of course you're adding accommodation by buying and removing accommodation by raising rates. That wouldn't be ideal, I'll say that."