The turning point is coming: That is why the US Federal Reserve is becoming less relaxed

The turning point is coming
That is why the US Federal Reserve is becoming less relaxed

The US Federal Reserve pumps $ 120 billion into the financial market every month. But now the scaling back of the crisis program is imminent. Fed Chairman Powell will turn things around in the evening.

The time has come. After its enormous aid programs in the Corona crisis, the US Federal Reserve wants to start tightening its ultra-loose monetary policy. With relatively high inflation and solid economic growth, the time has come in all likelihood: it would be a surprise if Fed Chairman Jerome Powell did not announce after today’s interest rate meeting that he would start an exit from the ultra-loose monetary policy.

The first step is likely to be to curb bond purchases. The question is not whether they will be reduced, but at what speed. The Fed is currently buying $ 120 billion in bonds every month. The program aims to improve the liquidity of the financial markets and facilitate the provision of credit for households and companies. Powell has secured broad consensus among central bankers on a plan to phase out the pandemic-born stimulus program by next June and cut purchases by $ 15 billion a month.

This operation to shut down bond purchases, known in technical jargon as tapering, marks a turnaround in monetary policy that has already triggered speculation on the financial markets that interest rates will rise in the next year. For today’s decision, one thing is certain: The key interest rate, which is in the extremely low range between 0.0 and 0.25 percent, will not yet be touched.

“The Fed will endeavor not to fuel this debate even further,” says Commerzbank chief economist Jörg Krämer. Powell recently pointed the way: it was time to cut bond purchases, but not to raise interest rates. That would be premature. However, the rapid rise in inflation is increasing the pressure on the Fed. In September the rate of inflation climbed to 5.4 percent, well above the Fed’s target of two percent.

Recovery in the labor market

The persistent supply problems in world trade meanwhile increasingly indicate that the significantly increased inflation is not – as initially assumed by the Fed – a relatively quickly temporary phenomenon. Powell admitted that himself in late October. The global bottlenecks in the supply chain, which would have led to increased inflation, “will probably take longer than previously expected, possibly well into next year,” said the central bank governor.

The design of the tapering already reflects a new schedule, which can be attributed to the greater unrest over the development of inflation. Earlier this year, the Fed had given investors the impression that it would cut bond purchases around January and that it could be almost a year before the end of this process.

But now it should go faster. The central bank had made substantial progress on the job market as a prerequisite for reducing its crisis aid. The recovery in the US labor market stalled somewhat in September, as the job increase was relatively low at 194,000. But as early as October, the bottom line could have been 425,000 new jobs – at least that is the consensus expectation of economists for the labor market report, which will be presented on Friday.

The unemployment rate had fallen to 4.8 percent in September – but it was not improving as quickly as the government had hoped. Meanwhile, employers in many industries are already complaining about a shortage of applicants. Before the pandemic, the unemployment rate was 3.5 percent – the lowest level in decades. So the US economy has recovered well from the crisis. The fact that growth in the summer months has lost considerable momentum due to supply bottlenecks in the industry and the increasing number of corona cases does not change anything.

Interest rate hike in prospect

“The slower pace of the US economy should not prevent the US central bank from letting its bond purchase program expire,” says LBBW economist Dirk Chlench. The lower number of corona cases should help ensure that growth will be slightly higher again in the fourth quarter.

The turnaround in monetary policy is imminent, says chief economist Thomas Gitzel from Liechtenstein’s VP Bank. There is simply no longer any need for the ultra-expansive line as an answer to the pandemic and its economic consequences. Gitzel points out that the Fed has doubled its bond holdings in the course of the corona crisis policy: its securities holdings are now around eight trillion dollars.

Meanwhile, the US bond markets are reflecting expectations of the Fed’s rate hikes next year. Last week, the likelihood of at least two rate hikes rose to 75 percent by the end of 2022. At the end of the Fed meeting last month, the probability was still around 20 percent.

It was only on Friday that Powell failed to confirm these expectations, which imply a first rate hike by the Fed in September. But neither did he contradict them.

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