The Great Tapering

The Great Tapering

The strong employment growth over the last several months, averaging over 900,000 non-farm payroll jobs, and an unemployment rate falling to 5.4%, moves the Federal Reserve toward intensifying its discussions as to the timing and magnitude of tapering bond purchases. Recently, a number of Federal Reserve Bank presidents, as well as board members, have indicated a desire to address the tapering issue sooner than anticipated. In fact, the many presentations by Fed officials could well be a part of the central bank’s plan to elevate the discussion about tapering and begin the discounting process.

The Jackson Hole symposium sponsored by the Federal Reserve Bank of Kansas City at the end of August is likely to provide insight into new research ideas surrounding the structure of future monetary policy and provide another forum for the discussion of tapering. That event will be followed by the September 21 and 22 Federal Open Market Committee meeting, which is likely to lay out the timeline and maybe even the magnitude of the tapering of bond purchases.

In my career I have experienced the changing nature and structure of monetary policy under 9 different Federal Reserve chairs over a 50-year span. The changes have been dramatic and heavily influenced by the Board chairs. Moreover, there have been times when intense political pressure existed, and other times international events swamped policy.

For example, as the Vietnam War escalated in the late 1960s, President Johnson pressured Fed Chair William McChesney Martin to delay tightening credit policy. In 1972, after imposing wage and price controls as a means to contain inflation, President Nixon cajoled Fed Chair Arthur Burns into a stimulative monetary policy. The subsequent policy reversal led to sharply rising interest rates.

In the coming months, Chair Powell or his successor will be facing similar pressure and the magnitude of any additional stimulus will likely determine the degree of pressure. As we move into 2022, a great deal will take place in the monetary policy sphere. Central banks are going to be grappling with a transition from a highly aggressive accommodative monetary policy to a lessening of that accommodation.

In my experience, the demands of federal financing needs will diminish the Fed’s independence. Central banks around the globe are becoming more beholden to their respective governments and it will become increasingly difficult to reverse that trend.

The virus, the vaccine, mandates, the supply chain, inflation, employment, taxes, etc., are all factors that will influence the policy environment over the coming months. Greater clarity will emerge on all these fronts, providing a more comprehensive setting for monetary policy to be formulated. However, in light of the multiple conflicting forces, the transition is likely to be slow and deliberate, and any increase in the Fed’s interest rate target should be in late 2022 or early 2023.

As we have indicated in the past, negative real interest rates (interest rate minus the inflation rate) are constructive for economic growth and equities. Further, economic growth and corporate profits should continue to rise significantly as the benefits of past fiscal and monetary policy take hold and reopening continues. Well-managed companies can benefit from rising prices (thus profitability) as they offset the input costs and at the same time implement technology to increase productivity. Moreover, the surge in corporate profits is prompting renewed buybacks. The buyback cycle is also being helped by corporate bond issuances to raise proceeds to buy more stocks. Also, dividend growth has returned in force.

Over 85% of the reporting S&P companies have exceeded estimates and over 75% have beaten revenue estimates. These results have lowered expected price to earnings (P/E) multiples and strengthened the foundation under the equity market. Although equities can be volatile as well as undergo corrections, they offer one of the better options to achieving investment success in an inflationary environment.