Fed may signal policy direction this week

This week’s meeting of the U.S. Federal Open Market Committee (FOMC) could hint at how the Fed will balance inflation risks with the uncertainty created by the latest stage of the pandemic, says Moody’s Investors Service.

In a new report, the rating agency said the FOMC’s post-meeting announcement on Dec. 15 will mark a step in managing a shift to a neutral monetary policy stance.

“If the market perceives that the Fed is behind the curve in controlling inflation, it would lead to higher inflation expectations and long-term interest rates, potentially weakening the dollar and affecting asset values,” Moody’s said.

At the same time, if the Fed overreacts to inflation, “it could result in tightening monetary policy too much, in turn dampening economic growth,” it said.

Among other things, the market will be looking for clarity on whether the Fed will accelerate the wind-down of its asset purchase program, along with signals on the timing of future rate hikes, the report noted.

“If the Fed announces faster tapering to end the bond purchase program, possibly by March 2022, it would more strongly signal that monetary policy is turning,” Moody’s said.

“Faster tapering is unlikely to jeopardize the economic recovery. Ongoing improvements in output and employment, despite occasional forecast misses, are strong enough to withstand slightly faster tapering,” it said, adding that “a faster taper would give the Fed the flexibility to begin raising rates anytime in the second half of 2022.”

Moody’s is currently forecasting rate hikes to start in early 2023, but said this timing could be accelerated “if inflation remains uncomfortably high.”

This decision is complicated by the emergence of the omicron variant, it noted.

“Even if the FOMC were to announce a quickening taper and an earlier end to bond purchases, the committee will likely stress data dependency with regards to the timing and pace of rate increases,” it said.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.