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waiting for the rate hike begins for the markets

The ease with which the markets digested the Fed’s announcement, with stocks hitting another record and bond yields rising just a few points (10-year yields up 4 basis points and 2-year yields up 2), says the Fed Has done an excellent job preparing markets for political change, or having been predictive in predicting and pricing change, or a little bit of both.

Powell continues to go to great lengths to distance the decision to begin the taper from the “lift off” – the moment the Fed raises the federal funds rate, which is currently near zero, for the first time since 2018.

While the markets have easily digested the throttle announcement, the Fed may find it harder to sell markets that have been addicted to and inflated by ultra-cheap and abundant liquidity since 2008.

He said the bank could be patient with rate hikes, although “if a response is needed we will not hesitate.”

Powell denied that the bank was “behind the curve” in developing its monetary policy, stressing that the tapering did not imply an imminent rate hike, as a decision to lift it would depend on further improvements in the labor market.

There is no indication that the problems in the supply chain have been resolved. Energy prices remain high. US companies reported cost pressures and labor shortages in the reporting season for the September quarter – cost increases that did not translate into lower margins because they passed them on to their customers, resulting in higher inflation rates.

If these attitudes continue next year, they will force the Fed, perhaps much sooner than it now expects.

Jerome Powell’s Fed has apparently admitted that inflation is not temporary.Credit:Getty Images

The markets are pricing in a 75 percent chance of two rate hikes next year, with a slightly less-than-even bet on three. Just a month ago, half of the members of the Open Market Committee were expecting one, the rest believed it would not increase until 2023 at the earliest.

While the Fed will buy fewer securities and pump less liquidity into already flooded markets, it will add another 540 billion to its already swollen balance sheet.

Its balance sheet will have expanded by more than $ 5 trillion in the pandemic or in just over two years. To provide context, during the series of quantitative easing programs in response to the 2008 financial crisis, the Fed bought approximately $ 3.6 trillion in securities over seven and a half years.

According to the GFC, the balance peaked at around 18 percent of US GDP. If everything goes according to the Fed’s new plan, it will rise to just under 40 percent of GDP.

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It’s not the only response to the pandemic, of course. Together, the top three central banks – the Fed, the European Central Bank, and the Bank of Japan – have bought about $ 9 trillion in bonds and other securities, or about a quarter of their combined GDP, in the most expansive period of the year to date, or about a quarter of their combined GDP in World Monetary Policy in history .

While the markets have easily digested the throttle announcement, the Fed may find it harder to sell markets that have been addicted to and inflated by ultra-cheap and abundant liquidity since 2008.

The last time the Fed started hike rates in 2018, there was a little tantrum in the markets, with the US stock market plummeting about 13 percent in a month. The market turmoil and a very serious conversation from Donald Trump, who viewed the stock market as a barometer of his success, caused Powell and the Fed to change course.

If the Fed is forced to hike rates sooner than expected, there could be another test of nerves and determination between the markets and the bank over the next year, with great volatility in the financial markets as the safety net appears to have been withdrawn for good since the financial crisis .

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