Taper Coming to an End

Rising inflation, a robust labor market and strong consumer demand has prompted the Open Market Committee of the Federal Reserve, the body that determines monetary policy, to scale back the purchase of Treasury Notes as well as Mortgage-Backed Securities.  This change in policy was announced after their most recent two-day meeting which concluded on Wednesday, December 15 and is being pursued in hopes that it will result in an easing of the upward pressure on prices and a cooling of economic growth, the latter of which may already be occurring as a result of the former as well as the Omicron variant of COVID.

The Fed began purchasing bonds during the first half of 2020, as the pandemic began to wreak havoc on the economy.  The net effect of these purchases has been to increase the supply of money, thereby acting as a tailwind to economic growth.  At its outset the Fed had been purchasing $120 billion of bonds per month prior to scaling it back to $60 billion in November 2021.  Beginning in January, the Fed will cut that figure in half to $30 billion which should slow consumption.  This period of tightening will end during March 2022, which will in turn pave the way for the Fed to begin raising the Fed Funds Rate, the rate at which banks borrow excess reserves from each other, from its current level of around 0%.  Currently ,twelve of the eighteen members of the Open Market Committee of the Federal Reserve expect at least three one-quarter point rate hikes during 2022, up from only one rate hike expected three months ago.

Within the release following the meeting were several statements that provided a clear picture of the Fed’s opinion of the current state of the U.S. economy as well as concerns going forward.  Specifically, “with progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen.  The sectors most adversely affected by the pandemic have improved in recent months, but continue to be affected by COVID-19.  Job gains have been solid in recent months, and the unemployment rate has declined substantially.  Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation.”

These inflationary pressures are evident in both the Consumer (CPI) as well as Producer Prices Indexes (PPI), monthly reports released by the Bureau of Labor Statistics and meant to gauge inflation at the retail and wholesale levels.  During November the CPI rose 0.8% which in turned pushed the year-over-year increase in prices up to 6.8%, and in so doing marked the largest increase in forty years.  Moreover, several key components have also spiked, including energy (3.5% m/m, 33.3% y/y) along with food and beverage prices (0.7% m/m, 6.1% y/y). Meanwhile, the PPI also rose sharply, increasing 0.8% during November and by 9.6% over the trailing twelve months, a record for this series which dates back to 2010.

Imbalances as referred to by the Fed or structural dislocation are visible also in the labor market, anecdotally seen through recent strikes at John Deere and Kellogg as well as in Weekly Initial Claims for Unemployment Benefits and the monthly Non-Farm Payroll Report as the number of unfilled jobs exceed the number of people looking for work.

For the foreseeable future, we believe investors are in for a period of increased volatility. However, we also believe that despite this volatility, the trend will remain to the upside as interest rates should relatively low on an historical basis and the Fed, on balance, accommodative.

Please note that all data is for general information purposes only and not meant as specific recommendations.  The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur.  Please research any investment thoroughly prior to committing money or consult with your financial advisor.  Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients.  Consult with your financial advisor prior to making any changes to your portfolio.  To contact Fagan Associates, Please call518-279-1044.