Does the decrease in bond purchases by the FED also mean a rise in interest rates?


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In September, when the United States Federal Reserve reported that the economy had made further substantial progress towards the committee’s goals and began to signal that it was going to start reducing asset purchases, a key point of his communication was that the end of the reduction did not coincide with the rise in interest rates.

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In its revised policy framework, the Fed defined the criteria necessary to retain their respective policy support tools. The cut and increase criteria were based on the committee’s goals of i) maximum employment, ii) two percent inflation, and iii) inflation expectation to moderately exceed two percent for a period of time, the committee said. requiring substantial progress towards those targets to start declining, whereas the targets had to be met for the conditions to be appropriate to raise interest rates.

In light of recent comments by Fed Chairman Jerome Powell to Congress on the possibility of stepping up the pace of the cut, markets have started to question whether these inflationary pressures have altered the Federal Reserve’s reaction function. compared to the framework defined when the US economy was in crisis. emerging from the pandemic at the end of last year.

As it stands, it has become increasingly clear that the criteria for inflation have been met and fears that inflation may continue to be more persistent are now raised. Still, uncertainty remains about the state of the labor market, especially the depressed participation rate from pre-pandemic levels.

What’s interesting is that the market opinion is that the end of tapering will coincide with take-off, and has been for some time. Looking at the implicit interest rate hikes built into the forward interest rate curve, following the official announcement to cut asset purchases by $ 15 million per month, markets had already integrated the first rate hike at the meeting immediately after the implied end of the reduction.

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While it is possible that the Federal Reserve will start raising interest rates once the phase-down process is complete, the market is once again viewing this possibility as its baseline scenario.

This is where the opportunity lies. If the future path of interest rates is delayed from the end of the reduction in the bond purchase program, real rates will stay low for longer, meaning that stock markets may stay higher for longer because there is an inverse relationship between interest rates and the stock market. values.

After all, unlike rising interest rates, tapering does not reflect political tightening in the traditional sense. Rather, it is the reduction in the rate of addition of stimulus.

And given the strength of the recovery so far, there’s a good chance the Fed will be more patient than the market expects before raising interest rates, in order to see how the economy reacts to a reduction in stimulus measures before jumping into a tightening cycle.

Mike Candeloro, Vice President, Portfolio Manager and Wealth Advisor at RBC Dominion Securities and Head of the Mike Candeloro Wealth Management Group wrote this article. RBC Dominion Securities Inc. and Royal Bank of Canada are separate legal entities which are affiliated. FCPE member. Mike can be contacted at www.michaelcandeloro.com

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