USD Rates: The odds of quicker taper


The Fed is running out of excuses to keep policy settings loose.
Eugene Leow17 Nov 2021
    Photo credit: Unsplash Photo


    Recent US data have been beating expectations. Retail sales printed 1.7% MoM sa (consensus: 1.7%) in October. Further breakdowns excluding autos, gas or measured via the Control Group were equally impressive. These suggest that US consumers are holding up well even as pandemic benefits have ended. Meanwhile, industrial production also rose by 1.6% MoM sa, significantly above expectations of 0.9%. Overall, it does seem that the dip in growth in 3Q is over and the economy remains firmly in recovery mode. Inflation is clearly the bigger risk in the coming few quarters.

    We think that the odds of an accelerated taper are significant. At the current pace, the Fed will cease quantitative easing around mid-2022. However, Fed Chair Powell only committed to the current taper pace till December. With growth rebounding and inflation clearly elevated, Powell might well use the option to end QE earlier, possibly towards the end of 1Q22. Clearly, the next payroll and CPI data points would be critical in determining whether the Fed needs to incrementally turn even more hawkish. One way to gauge the odds of early taper would be to look at Fed funds futures pricing for mid-2022. We assume that the Fed would only hike after QE has ceased. Operationally, there is nothing stopping the Fed running QE and hiking rates, but communication could be difficult. With July’s Fed funds futures pricing in a hike, the market is saying that QE would end in July, at the latest. There is also a decent probability (we pin at around 40%), that QE would end earlier to allow the Fed some time to observe the economy before hiking rates. In any case, there is little justification for asset purchases at a time when financial conditions are loose, growth is firm and inflation risks are rising. The Fed is running out of excuses to keep policy settings loose.

      

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]

     
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