A hawkish surprise? Key takeaways from the September Fed meeting
On the latest edition of Market Week in Review, Director of Investment Strategies Shailesh Kshatriya and Head of Portfolio & Business Consulting Sophie Antal Gilbert discussed recent central bank meetings, the latest developments surrounding Chinese property developer Evergrande and potential market impacts of a U.S. government shutdown.
Fed signals tapering announcement likely by end of year
In a week of competing headlines for markets, there was heightened interest in the U.S. Federal Reserve (the Fed)’s policy meeting, held Sept. 21-22, Kshatriya said. While the central bank kept interest rates anchored near zero and made no changes to its asset-purchasing program, he noted that it did offer clues around when it’s likely to begin tapering monthly bond purchases—and at what pace.
“The Fed indicated that if progress toward full employment and price stability continues as expected, a moderation in asset purchases may soon be warranted. Given this statement, I believe that a formal announcement on the tapering timeline is likely at the central bank’s Nov. 2-3 meeting, with tapering probably commencing in December,” Kshatriya stated.
He noted that while the Fed’s statement on tapering was largely expected, comments made by Chairman Jerome Powell in the ensuing press conference came as a bit of a hawkish surprise. “The Fed chair indicated that tapering could end around the middle of next year, which suggests that the whole tapering process will take about six to seven months—a few months less than we’d been expecting,” Kshatriya said. An earlier-than-anticipated end to the Fed’s quantitative-easing program could potentially mean an earlier-than-anticipated start to rate hikes, he explained.
The updated dot plot1 from Federal Open Market Committee members indicates as much, Kshatriya noted, with 9 of 18 members projecting a rate increase in 2022. “Our strategist team still believes that 2023 is the most appropriate time for liftoff to occur, but based on the latest dot plot, a 2022 rate hike can’t be ruled out if certain conditions are met,” he said. Those conditions are two-fold: full employment and average inflation of about 2%, Kshatriya added.
In his viewpoint, as long as the labor market remains strong, the Fed is likely to achieve its goal of maximum employment over the next 12 months. The bigger question, Kshatriya explained, revolves around what happens with inflation in the same timeframe. “I expect inflation to moderate down to around 2% over the next 12 months,” he said, “but if it’s still elevated a year from now—amid full employment—a rate increase in late 2022 can’t be discounted.
Kshatriya noted that in addition to the Fed, the Bank of England (BoE) and Bank of Japan (BOJ) also held policy meetings the week of Sept. 20. The BoE also left its key interest rate unchanged and made no changes to its asset-purchasing program, he said, but bank officials did express concerns around the outlook for inflation. “There are now some indications that the central bank could raise rates sooner than thought—perhaps as early as the first quarter of 2022,” Kshatriya said, characterizing the latest developments as hawkish in nature.
The BOJ also kept its rates unchanged, but unlike the Fed and BoE, indicated that its ultra-easy monetary policies will remain intact for the foreseeable future, he noted. “The BOJ will likely be a laggard among other key central banks when it comes to policy tightening,” Kshatriya remarked.
Do Evergrande’s debt woes pose a risk to global markets?
Headlines surrounding Chinese property developer Evergrande also commanded the attention of markets the week of Sept. 20, Kshatriya said. “There’s been some concern that the heavily indebted company, which has missed a couple of interest payments, could roil Chinese markets in a manner similar to how the collapse of Lehman Brothers impacted U.S. markets in 2008,” he noted.
An important indicator Kshatriya is using to monitor this risk are Chinese high-yield credit spreads—and how they compare relative to their global high-yield counterparts, as well as Chinese investment-grade credit itself. “So far, Chinese high-yield spreads have clearly risen, but I haven’t seen a significant spillover into Chinese investment-grade credit—and more importantly, much of an impact on global high-yield credit. This suggests that contagion risks haven’t really materialized within China or globally,” Kshatriya stated, adding that the risks of a global contagion appear minimal at this point in time.
In addition, if risks were to significantly escalate, Chinese policymakers could step up policy easing measures down the line, Kshatriya said, noting that the People’s Bank of China recently injected cash into the financial system to ensure adequate liquidity. He also noted that while Evergrande has several bond payments due over the next few weeks, a 30-day grace period exists—meaning that a missed payment doesn’t automatically trigger a default.
“Overall, while this saga is far from complete, I don’t see a systemic risk to financial markets unfolding at this time,” Kshatriya concluded.
Key watchpoints for markets: Potential U.S. government shutdown, debt-ceiling standoff
Kshatriya and Gilbert concluded the segment with a look at the potential for a partial U.S. government shutdown, which would occur if Congress doesn’t pass a bill to fund the government beyond Sept. 30. “We’ve seen this movie before,” Kshatriya said, noting that the U.S. government was shuttered for a record 35 days during the winter of 2018-19. He remarked that during this timeframe, U.S. equity markets rose by roughly 10%. “This shows that while a government shutdown is clearly headline-grabbing, it’s not always problematic for markets,” Kshatriya explained.
Another pressing issue for policymakers in Washington, D.C., is the need to resolve the debt-ceiling—or federal borrowing limit—impasse between Democrats and Republicans, he noted. Kshatriya explained that if a resolution is not reached soon, the U.S. government will run out of money to pay its bills at some point in October. That said, he stressed that it’s very difficult to imagine Congress knowingly allowing the U.S. to default. “While there’s clearly a lot of political posturing taking place in the background and behind the scenes, ultimately, we do believe the debt-ceiling issue will be resolved,” he stated, noting that House Speaker Nancy Pelosi has indicated that some type of a resolution is in the works.
1 A “dot plot” is a graphical display of data using dots. The Fed’s dot plot maps out policymakers’ expectations for where interest rates could be headed in the future.