The start of the U.S. Fed’s “talk about talking about tapering” could heighten the impact incoming jobs and economic data will have on rates. Kim Parlee speaks with Priya Misra, Head of Global Rates Strategy at TD Securities, about what higher rate sensitivity could mean for markets.
- Let's start with the Fed saying that they're beginning to talk about talking about tapering. That was really enough to send equity markets lower when they announced it but was this a really big shift for the Fed?
- Hi, Kim, thanks for having me. I think the market was really confused by that Fed message. I think the reason equities fell, the reason long and interest rates actually fell was I think the market interpreted the Fed message as a more hawkish reaction function, that perhaps the commitment to the flexible average inflation targeting framework was not as strong as it was a year ago. And so people read that as a hawkish shift which is why discussants underperformed. We actually read it as the Fed acknowledging that the data has come in much better than their forecast, much better than private forecasters and it was more of a risk management exercise.
If economic data remains very robust over the next few months, they should probably taper. But that doesn't mean that the Fed is ahead of the curve or that they are making a policy mistake. We rated more as acknowledgment that the economic outlook looks a lot more positive and they probably have far more confidence in their baseline recovery forecast than they did in March.
- OK, so what does that mean for your Fed call? I understand you've got a new Fed call.
- We changed our Fed call yes, because the data and some of it was an acknowledgment on our end that the data has come in stronger and the fact that the Fed is at least talking about tapering which means that the next few months, they're going to spend analyzing the data.
Given that our economists have a strong growth and inflation forecast over the next six months, we actually think that they'll have enough data in order for the Fed to taper. So we moved out tapering or from next year into December. We think they'll announce tapering in December. They'll conduct tapering from January of '22 until October. And then a year from now, or a year from then to actually hike. So we changed our Fed hike call as well to December, 2023. So that's still further out in the market's pricing in but it was an acknowledgment that the Fed is taking the improvement in data seriously.
- You talk about the data and how closely they're going to be watching it and that improvement that we're seeing, I understand from your note that non-farm payrolls is going to be high on that list.
- It is and now it is a very important data print for would take for global markets certainly for the US through its market. And when the Fed suggests that they are talking about tapering time frame, over the next few months, I think the significance gets more important. And we saw this in the last cycle as well economic data did not have as much of an impact on rates or on broader macromarkets while the Fed was doing QE because if they are doing QE maybe the data doesn't matter.
When Bernanke in 2013 began to talk about tapering is when data sensitivity began to rise. And it's a little tricky because data is very hard to predict right now and I think it gets hard because there's a lot of reopening impacts on the economy, there's fiscal stimulus, there's a lot of supply chain disruptions. So I think we're going to have volatile data potentially much harder to predict and that's going to move markets. Because we know that the Fed has just put us on watch that tapering is a next six months phenomena.
- OK, so let's talk a bit about then the data, non-farm payrolls are important. You mentioned the fact that we have uneven reopenings and in some cases closings again that we're seeing in different places. So when you think about employment, services I know used vehicle prices people are watching wages what are you watching for what do you expect to see?
- So we expect to see continued growth in the labor market, particularly when schools reopen. Once you're in that September time frame assuming COVID cases remain low. And again even if they start to pick up if hospitalisations is not picking up, I think that's our best case that the labor market will show signs of improvement and inclusive improvement. And for that, we need to see the service sector really rebound. We are looking for that maybe not the next couple of months, but into the end of the year.
On the inflation front, we expect to see continued price pressures. But if it remains in COVID-impacted sectors we think that's transitory that's going to not put that much pressure on the Fed to exit earlier. If we start to see education, health care, broad service inflation start to pick up, I think then the Fed gets nervous that this is no longer transitory.
But in our analysis right now we're still seeing enough slack in the economy that the other price pressures stay low it still largely remains used car prices but I think that's plateauing. Some of the high frequency data suggesting that there was a supply chain disruption and all the time that supply is starting to pick up. So I think it's plateaued by the end of the year we expect some of those forces to actually abate.
- Priya, I've only got about 30 seconds but I'm curious I mean it's been a bumpy ride for the past little while in the markets, do you expect expected to be a bumpy summer too just based on all of this?
- I think given that data is inherently volatile and now particularly is hard to predict, I think it will likely be bumpy as data comes in and we're trying to reassess what is the Fed exit. But I do have faith in the Fed that they haven't given up the average inflation targeting regime. So ultimately I think we're bumpy within a range. I don't think we break the range. I don't think the Fed is about to signal tapering in the next month or two. So it might be a volatile ride but I would say that overall I still have faith that the reflation trade is still on.
- Fascinating, Priya, always a pleasure. Thanks so much.