MNI STATE OF PLAY: Fed Nears Taper, Dots to Skew Hawkish

The Federal Reserve on Wednesday is expected to affirm its commitment to start winding down pandemic-era stimulus policies this year by paring its USD120 billion monthly asset purchase program, while fresh economic projections could also signal a more aggressive approach to eventual interest rate hikes.

Policymakers are unlikely to take any policy action at the September meeting, but they may agree internally on a November announcement for a QE tapering plan unless the job market sours.

The FOMC will also keep the benchmark fed funds rate at a rock-bottom 0% to 0.25% range, but surprisingly high inflation since June could stir up growing support for raising interest rates next year. The surge in Delta variant Covid cases acts as a countervailing force, however, and the uncertainty could see some FOMC members holding off from advancing rate hike dots, former Fed officials said.

Once rates lift off, the ex-officials said they expect rates to march higher each quarter until they hit neutral as the economy nears the Fed's dual mandate goals.

REINING IN INFLATION

Fed inflation forecasts for this year are likely to be upgraded again to reflect supply shortages, while views on next year will remain anchored near 2% as price pressures showed some signs of peaking while coronavirus variant risks remain, ex-officials said.

Risks to the inflation outlook are likely to be more balanced now compared to June, when every FOMC member saw risks to the upside, but prominent ex-officials are airing concern that Fed complacency could pave the way to a dangerous unanchoring of price expectations.

Prices have risen at double the Fed's target for several months. Supply chain disruptions are proving more longer lasting and surging home prices could put upward pressure on U.S. inflation for years to come, current and former Fed staffers told MNI.

EMPLOYMENT OBJECTIVE

The FOMC has said it would keep rates near zero until it sees a broad and inclusive recovery in employment in addition to hitting its inflation goals. However, the labor market objective is drifting farther out of reach, with Covid's Delta variant driving disappointing August jobs numbers and slower growth overall.

PMI surveys have shown firms reporting hiring difficulties as a major barrier to boosting output, but a long hoped-for rebound in workforce participation after schools reopen and jobless benefits expire may not materialize quickly, Federal Reserve economists told MNI.

New research suggests workforce participation rates are less influenced by unemployment benefits and school reopenings than by concerns over catching Covid-19, and may only improve well after unemployment bottoms.

Labor participation held steady in August at 61.7%, unchanged from a year ago and still 1.6pp short of prepandemic levels. Unemployment recovered to 5.2% from a high of 14.8% in April 2020.