U.S. central bank rolls out plan for slowing stimulus this year and rate hikes in 2022

With markets on edge from a series of recent disruptions, this is no time for another taper tantrum, where stocks tumble on the news that stimulus may come to an end. Nonetheless the U.S. central bank has officially revealed plans to slow down its purchase of bonds and begin raising interest rates.

Despite worries over a spreading property meltdown in China, rising delta cases, a fight over the debt ceiling in Washington and worldwide concern over the impact of higher rates on public and private borrowing, U.S. Federal Reserve chair Jerome Powell said Wednesday that he is confident it is finally time to plan an end to pandemic stimulus.

There are two stages to the rollback in monetary stimulus that will gradually make money harder to borrow. The first, Powell projects, will come as soon as November, when the world's largest central bank scales back, or tapers off on its weekly purchase of billions of dollars in bonds. That process could be complete by mid-2022.

But just because he's now finally talking about cutting stimulus doesn't carve this path in stone. 

Taper time mean higher rates

In the past, such announcements that the Fed was beginning progress to cut monetary stimulus has resulted in a wave of stock-market selling, dubbed a taper tantrum, as traders adjust to the idea that an era of bargain borrowing is coming to an end.

To those not familiar with the process, the reason for a market tantrum may require a little explanation.

Besides cutting official interest rates almost to zero, central banks around the world, including the Bank of Canada, have been buying bonds to force interest rates on things like mortgages and business loans even lower, as deputy governor Paul Beaudry has explained.

Ending that process, called quantitative easing, not only makes mortgage debt more expensive, but is part of a chain of events that will lead to higher interest rates across the board. Because of the impact of U.S. bond markets on Canadian rates, that will also affect borrowers north of the border.

"The test for beginning our taper is that we've achieved substantial further progress toward our goal of inflation and maximum employment," Powell told reporters at the Wednesday virtual news conference. He said that members of the committee that make U.S. monetary policy are convinced the bank has already over-achieved its goal on inflation.

"Many on the committee feel that the substantial further progress test for employment has been met," he said, although progress on jobs had been slowed because "delta happened."

More than half of that committee foresees the actual bank interest rates beginning to rise by next year, coming closer to estimates of private sector economists who have already anticipated a half-point hike in 2022. 

Chinese property contagion

While Powell recognized some the headwinds faced by the global and U.S. economy, he seemed confident that they would not impede the progress of the economy in meeting the bank's employment goals.

For example, he said there was no sign that the China property crisis, specifically the threatened default of Evergrande that has led to tightening of credit throughout China's enormous home-building sector, would have a direct effect on U.S. corporate defaults that he saw as continuing to be "very low."

"In terms of the implications for the U.S., there's not a lot of direct United States exposure," said Powell. "But you know, you would worry that it would affect global financial conditions through confidence channels."

The other thing that could threaten U.S. economic stability this autumn is another battle in Congress over raising the debt ceiling limit, an issue that has got less attention in Canada than in the past because of domestic election coverage.

"It's just very important that the debt ceiling be raised in a timely fashion so that the United States can pay its bills," said Powell. "The failure to do that could result in severe reactions, severe damage to the economy and the financial system."

In the past, after playing chicken for a number of weeks, Congress has always managed to hammer out an agreement to prevent the government from defaulting but so long as that threat lingers, there is a possibility the plan to begin tapering would be delayed.

Ever since Powell's comments that he was not even "talking about talking about" cutting stimulus, the world's most powerful central banker has promised that he would not begin scaling back on the purchase of bonds until he had announced it to the world.

Many expected he would delay again. This week, the OECD, the rich countries' economic think tank, advised governments and central banks to hold off on cutting stimulus. But Powell's decision is still not final.

With things like Evergrande, the debt ceiling and the uncertainty of the delta variant, and even the potential effect of a new taper tantrum, Powell said the choice of whether to step on the bottom of the interest rates escalator will actually come in November, the next time he's scheduled to hold a news conference.

"We could easily move ahead at the next meeting," said Powell, sounding confident, before quickly adding, "Or not." 

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