KEY DATA: LEI: +0.9%; Claims: +16,000
IN A NUTSHELL: “The Fed is intent on ending its flooding of the markets with liquidity and then raising rates for the simple reason that the economy is in good shape.”
WHAT IT MEANS: It looks like the only thing about the expected economic slowdown that is slow is the pace at which it is arriving. If the Conference Board’s Leading Economic Index tells us anything, and it usually does, then we still have some strong growth ahead of us. The index jumped in August, after a major rise in July. Only a decline in confidence, which we cannot take for granted, restrained the increase. The report noted that growth this year could hit 6% and still be 4% next year. Yes, the slowdown is coming, but it is a way off.
Weekly initial claims for unemployment insurance jumped last week, which was a surprise. Since hitting its post-recession low on September 4th, the number of people applying for assistance has increased. These data are volatile because it is impossible to get an accurate seasonal adjustment for weekly data, so don’t read too much into the recent increases.
Yesterday’s FOMC Decision: Tapering is coming “soon”, and not much later rate hikes will begin. Is the sky falling? Hardly. It’s the opposite. The sky is brightening. Yes, the Delta variant is still a wildfire in many parts of the nation, and that will be the case until it hopefully burns itself out. That should have happened already, but given the large percentage of the population who will not get vaccinated, there remains plenty of tinder to burn through. Yet the economy continues to move forward, and today’s data don’t point to any major slowdown in the near future. It was in that light that the Fed, through its statement and more importantly the comments made by Fed Chair Powell at his press conference, determined that the days of extremely easy money need to come to an end.
Keep in mind, the Fed will be still adding to liquidity until about the middle of next year, it’s just that the amount will be reduced, probably monthly. As the Fed members have noted in the past, first comes tapering, then come tightening. And if you look at the infamous “dot plot” of Fed funds forecasts, half the members expect a rate hike by the end of next year. Barring another variant creating even more havoc, or a massive Chinese meltdown (not expected), that looks like a good bet right now. Whether the hike comes in the fourth quarter of 2021 or the first quarter of 2022 is irrelevant, it is coming. The economy should continue to grow solidly next year, though more moderately. But that should be enough to bring unemployment rates down close enough to 4% for the Committee members to declare victory. Indeed, 4% is their long-run full employment target. The only issue is inflation, which is still running well above the 2% target. The members still say that is transitory. In, addition, the statement reminded us that “With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent.” In other words, the Fed is quite willing to live with high inflation for an extended period.
When you put this all together, it is time to begin planning for rising rates. Investors should start factoring in not just a lower amount of liquidity flooding the market, but the inevitable move toward the Fed reducing its balance sheet. Since these actions are coming because the economy is healing and will once again be able to support normal interest rates and a more passive Fed, I will take it. The next FOMC meeting is November 2,3 2021. Given Mr. Powell’s statement that the announcement on the start of tapering could come as soon as November, expect that to happen.