U.S. Federal Reserve leaves rates unchanged, but signals tapering is coming. Anthony Okolie speaks with Scott Colbourne, Managing Director, TD Asset Management, about the Fed’s continued efforts to strike the right balance between a dovish and hawkish stance.
Hi, Tony. We're looking for a few things out of the Fed today, and the first thing I was looking for is an indication as to whether we were going to get advance notice on tapering. And we got some language that the Fed said, if the conditions continue as expected, moderation in the bond buying program may be warranted sooner. And so the market is sort of taking that as a probably a November start to tapering. And the other other big thing that we can talk about is the dot plots or, every quarter they release the summary of economic projections and the SEP that give us an indication on the forecasts, whether it's for growth, inflation, and interesting, obviously, for fixed income investors, where the interest rates are going to go.
Now, the Fed also raised their inflation outlook for the rest of this year, but they still maintain that it's transitory. Do you agree with this assessment?
You know, it's a really important question that the markets are grappling with. We believe that the inflation outlook is a transitory trajectory. But I think there are strong opinions on both sides. And I think the most important thing to be monitoring as we move through and evaluate whether it is transitory is whether the stickiness in housing prices and how that feeds into inflation, and as well on the labor market. And certainly we've seen a lot of pressure on the labor market. So it is an evolving market development. I think we'll we'll closely focus on that. But by and large, market measures of inflation expectations continue to be relatively in hand and lean into that thesis that the inflation is a transitory phenomenon.
And Scott, we continue to see a flattening yield curve. Now, why aren't long term yields higher, given that the Fed has been signaling its tapering of stimulus?
So when you look at the DOT plots today, for example, 2022, we now have one rate hike priced in. The median dot plot is for one rate hike in 2022. In June, it was zero. And now in 2023, we have a full four hikes priced in. So that was two in June and then for 2024, which is a new part of the projection this month, they have interest rates going to about 1.75%. So we have a trajectory of where the Fed thinks rates are going. And when the curve is pricing this in, what we see is perhaps the Fed pricing and hike sooner in the forecast horizon rather than later. And as a consequence, we get a bit of a flattening in the yield curve. And we did get a little surprise on those dot plots. It was a little surprising. I would characterize it as mildly hawkish for the markets, but it is definitely a flattening bias to the yield curve.
I'm glad you mentioned markets beyond inflation and the job market recovery, is the Fed considering other factors, including the debt ceiling and the events around the embattled Chinese property developer Evergrande, which roiled markets earlier this week?
There's lots of headwinds in the market these days, and certainly the Fed marked down its growth forecasts. And part of that is impacting the trajectory of where their forecasts are going. The developments in China, we've seen growth slowing down for some time. The Evergrande story is not new, but certainly at the margin it is another growth negative story. So net net, you've got headwinds for growth. You've got a very fluid situation on the fiscal side with the debt ceiling and negotiations for stimulus and a lot of uncertainty there. And as we touched upon on inflation, a lot of uncertainty there. So it is a difficult time period to navigate. And I think what the Fed is trying to do is slowly introduce the concept of tapering here, without trying to roil the market too much, given the substantial number of headwinds that the market is facing going forward.
And finally, where do you see the US dollar going the next little while?
Well, the initial reaction of today was a slightly weaker US dollar, but I think over time, as the Fed rate hikes and the end of taper play out, it'll be mildly supportive for the US dollar. We've seen a stabilization in the US dollar as we've seen more rate hikes priced in. So I'm leaning right now towards a stabilization in the U.S. dollar and a slight uptick as we face growth headwinds and uncertainties in the market going into the latter part of this year and into 2022.
Scott, thank you very much for your insights.
My pleasure. Thanks, Tony.