Can the Fed avoid panicking the markets as it prepares for a gradual decline?

Federal Reserve Chairman Jerome Powell However, they announced that the central bank will take the first steps in cutting back on extraordinary monetary stimulus, hoping that markets won’t spoil in response.

Comments from Federal Reserve officials over the past few weeks pointed to an announcement on November 3 that the central bank would slow its quantitative easing program.

For months, markets have been wondering when the Fed will “lower” the pace of US Treasuries and agency purchases of mortgage-backed securities, which the Fed is currently absorbing at a pace of about $120 billion per month.

Hotter-than-expected prints on inflation have policy makers inclined to take the Fed’s foot off the accelerator pedal. Although Fed officials have stressed the need to fill the 5 million job shortfall, policymakers insisted that interest rates near zero should continue to support employment as they taper off.

“I think it’s time to roll back, I don’t think it’s time to raise rates,” Powell said October 22.

The central bank has been very careful not to disturb the boat as it prepares to undo its tools. The slowdown in bond and stock purchases isn’t a direct link to the more powerful tool for raising interest rates, but markets are already reading tea leaves on tapering to price expectations for an eventual rate hike.

Some Fed officials are already indicating that their attention has turned to interest rates.

“If we continue to see inflation at 4% or in that area next spring, I think we may have to reassess how quickly we are going to consider raising rates,” Fed Governor Randall Quarles said. He said on October 20.

Watch bond yields

The actions of other central banks are a cautionary tale of the swings that the pivot offers in policy.

At the Bank of Canada, it was announced The sudden stop of the asset purchase program shook investors On October 27, which dumped Canadian bonds and raised government bond yields.

US yields have already shown some sensitivity during the recent trading sessions. Long-term bond yields, such as 10 years (^ degeneration) and 30 years (^ TYX), had days where returns would swing by five basis points or so in either direction.

On the short end of the curve, the US Treasury has risen for two years over the past month alone, reflecting expectations of nearly twice the Federal Reserve raising interest rates through 2023. 50-50 . split As of September on whether or not he could see his first rate hike next year.

The FOMC’s updated Economic Outlook Summary shows that the 18-member committee is evenly split on whether or not they should start raising rates next year. Source: Federal Reserve

“Everyone is trying to make their best guesses as to what is going to happen and when it’s going to happen,” Rebecca Felton of Riverfront Investment Group told Yahoo Finance on October 28. We see these returns continue to fluctuate.”

For his part, Powell declared victory in his message to the markets – at least on tapering.

“I think the market generally understands where we are now,” Powell said on October 22.

The question is whether the markets realize where the Fed is going to raise interest rates in the future. The Federal Open Market Committee will meet on November 2 with its policy statement expected on November 3.

Brian Cheung is a reporter covering the Federal Reserve, the economy and banking at Yahoo Finance. You can follow him on Twitter Tweet embed.

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