Is Taper Talk About to Begin?

According to the minutes of the Fed's last meeting in April, "a number of participants suggested that if the economy continued to make rapid progress toward the committee's goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases."

Is this week's meeting the start of that discussion? We'll find out Wednesday afternoon at 2:00 PM EST.

The announcement following the April meeting reiterated the Fed's stance that it "will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer-term inflation expectations remain well-anchored at 2%." As we know, Fed officials have maintained that the recent surge in inflation well above that level is only "transitory," although they have eased off that insistence over the past month.

Last week's consumer price index report for May should give them a lot to think about this week.

The year-on-year increase in the headline CPI was 5.0%, well above even the highest Street forecast and the prior month's 4.2% jump. The core index, which excludes food and energy prices, rose 3.8%, up from April's 3.0% rise.

While the comparisons to last year – when the pandemic-induced lockdown was in full force – are somewhat distorted, the fact is that the increase in the headline number was the steepest since August 2008 and the core index's the largest in nearly 30 years.

The YOY CPI increase has now risen above 2.5% in each of the past three months. While that probably doesn't qualify as "for some time," it certainly should provoke a serious discussion at this week's meeting.

So should last week's report on unemployment claims, which fell another 9,000 to 376,000 for the first week of June. Claims have now fallen seven straight weeks and are down by nearly half from the April 4 peak of 742,000. While that's surely too many people still collecting unemployment benefits, the numbers are undoubtedly skewed by the number of people receiving bonus benefits, which makes it more advantageous not to work until those benefits run out. Recent reports of companies like Amazon and McDonald's paying fat upfront bonuses for relatively low-paying jobs would tell you that we're a lot closer to a full-employment economy than May's 5.8% jobless rate would indicate.

The Fed has started to drop other hints that it's ready to start "thinking about thinking about" a change in monetary policy, to use Fed Chair Jerome Powell's words from a year ago, when he flat-out rejected the idea of any imminent rise in interest rates. To little fanfare, the Fed said two weeks ago that it will soon begin selling off the $5.2 billion of corporate bonds and $8.5 billion of corporate debt ETFs that it bought last year as part of the emergency Secondary Market Corporate Credit Facility.

Granted, $13.7 billion is a rounding error at the Fed – it only talks in trillions – so maybe the announcement didn't deserve much attention. After all, the Fed's balance sheet is nearly $8 trillion. It said at the April meeting that it "will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee's maximum employment and price stability goals."

While it's debatable whether the Fed should continue to be patient in waiting to raise rates and reduce asset purchases until the economy gets back to full tilt, other factors argue for a more immediate change in monetary policy, meaning before the end of the year. You'll notice that long-term U.S. Treasury rates have barely moved since all this inflation talk started – in fact, they've gone down. Last week, the yield on the benchmark 10-year note fell below 1.5% for the first time since March. Why would anyone buy a 10-year security at that level with inflation recently running at 5%?

The answer, of course, is that there aren't many other safe places to go. The Fed has flooded the financial markets with so much money that it distorts yields and asset prices. The Wall Street Journal reported last week that banks are taking in so much money in deposits that they're asking their corporate customers to keep it. Bank deposits totaled more than $17 trillion at the end of May, the paper said. While that might normally be a good thing, the banks can't put that money to use because loan demand is so weak – total loans equaled only 61% of deposits at the end of May, down from 75% in February 2020, just before the pandemic started.

With so much money and so few productive places to put it, many investors are putting it into meme stocks, bitcoin, and other speculations, which create problems of their own. At what point will the Fed focus on that?

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.