MNI STATE OF PLAY: Fed To Taper QE As Risk of Inflation Rises

The Federal Reserve at its meeting Wednesday will start a rapid wind-down of its pandemic-era asset purchase program, beginning the countdown to potential interest rate hikes next year amid the growing risk that high inflation won't soon subside.

Having notched substantial progress toward a full labor market recovery, the FOMC is expected to announce a tapering of net purchases of Treasuries by USD10 billion a month and mortgage securities by USD5 billion a month, ending the USD120 billion monthly QE program by mid-2022.

Tapering will continue on auto-pilot as long as the economy evolves in line with the Fed's outlook, the FOMC is expected to say, but the bar will be high for altering course. Markets are pricing in more than two rate hikes next year, but the order of the Fed's exit plans may prevent rate rises from moving much earlier into 2022, former staffers told MNI.

At this week's meeting, Chair Jay Powell is also likely to deliver a more hawkish message on inflation, noting that supply bottlenecks and worker shortages have not eased as the Fed had earlier expected.

'TRANSITORY' MAY BE OUT

Both headline and core PCE inflation jumped at their fastest pace in 30 years in September and one survey measure last week showed consumer price expectations at their highest since 2008, accompanied by expressions of greater uncertainty than at anytime in nearly four decades. The 5-year breakeven inflation rate also topped 3% for the first time on record last month.

For the past six months, officials have described reopening-related price increases as largely "transitory," but the Fed appears to be gradually moving away from that language now that higher inflation could persist well into next year, former Fed officials and staffers told MNI.

A communications shift could see the central bank put less emphasis on the word "transitory" in spoken remarks, though it might be too soon to remove it from the FOMC statement in case this sends too hawkish a message and unsettles markets.

SHRINKING LABOR POOL

Continued high inflation next year could also drive the Fed to reassess its guideposts for maximum employment, former senior officials have told MNI.

By the time tapering concludes mid-2022, policymakers could also be ready to concede that unemployment and workforce participation rates may not recover to pre-pandemic levels, and to declare the maximum employment objective of the Fed's dual mandate met.

Demand for workers has propelled job openings to record levels, leading to higher pay and a speedy recovery in the unemployment rate to below 5%. That's prompted a vocal minority of policymakers to argue that what slack there is in the labor market will soon be absorbed, despite the fact that some 5 million Americans have yet to return to work.