The Fed accelerates tapering and foresees more hikes in 2022 and 2023

As it was fully discounted by the market, the Fed left the benchmark interest rate unchanged in its last monetary policy announcement of the year.

However, the market’s attention was focused on possible changes in the rate of reduction of the liquidity injection program, that is, the tapering process, and the publication of new macroeconomic estimates.

As we anticipated in Tuesday’s edition of Without Borders, the Fed announced a considerable acceleration in the tapering process, advancing the conclusion of the quantitative stimulus program from June to March.

Since its inception in April 2020, the Fed had been pumping $ 120 billion a month into the markets by buying Treasury bonds ($ 80 billion) and mortgage bonds ($ 40 billion).

In the monetary policy decision of November 3, the Fed announced that as of that same month it would be reducing its program of liquidity injections by an amount of 15,000 million dollars per month (10,000 million dollars in Treasury bonds and 5,000 million in mortgage bonds).

The rhythm announced in November foresaw the end of the stimulus program for June 2022.

In yesterday’s announcement, December 15, the Fed announced that as of January the rate of reduction will increase to 30,000 million dollars per month. Taking into account the reductions in November and December, the Fed still injected $ 90 billion of liquidity into the market this month.

With the monthly reduction of $ 30 billion, the program should end in March.

This early conclusion opens the door for the Fed to begin a cycle of rate hikes as early as its May policy meeting.

The content of the communiqué and the revision of the macroeconomic projections show that the main focus of the Fed has shifted from the goal of full employment to the goal of price control.

The adjective “transitory” that the Fed had repeatedly used to describe inflation disappeared entirely from the statement and comments prepared by Fed Chairman Jerome Powell at the press conference.

The change in priorities for the Fed is also evident in the revisions to the macroeconomic estimates and the update of the dot plot that reveals the expectations of the 18 members of the FOMC regarding the funding rate for the closing of every year.

In the case of 2022, now all 18 members anticipate interest rate increases compared to just nine members in the last dot plot release in September. The median funding rate estimates at the end of 2022 rose from 0.25 to 0.9%, which implies that most FOMC members anticipate three increases in the funding rate next year.

Additionally, the new dot plot reveals that the majority of FOMC members expect another three increases in 2023 and another three in 2024, with which the funding rate would end in 2023 at 1.6% (vs. 1.0% in the previous publication. ) and 2.1% for 2024 (vs. 1.8% in the previous publication).

These increases in rate expectations are directly related to a strong upward revision in inflation estimates.

Specifically, the FOMC members raised their core inflation estimates for 2021 from 3.7% in September to 4.4%, for 2022 from 2.3 to 2.7%, and for 2023 from 2.2% to 2.3 percent.

In this context of a less accommodating Reserve, Banxico must be forceful in its decision. The first step would be to increase the funding rate by half a point and reaffirm its commitment to fighting inflation.

If you choose to only make a quarter point increase, the language of the statement had better be very forceful. Otherwise, we could see further weakness in the peso’s price against the dollar.

For holidays, this column will return on January 4. Best wishes to all readers.

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Joaquín López-Dóriga Ostolaza

Socio Director de EP Capital, S.C.

Without Borders

Joaquín López-Dóriga Ostolaza is Managing Partner of EP Capital, SC, a consultancy specialized in mergers and acquisitions founded in 2009.

He is a graduate of the Bachelor of Economics from the Universidad Iberoamericana, where he graduated with honorable mention and the highest average of his generation. He has a Master’s degree in Economics from the London School of Economics, where he was distinguished with the British Council Chevening Scholarship Award.

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