The debate around when the Fed will begin to taper its QE program continues unabated, but on the desk here, we are increasingly questioning why it hasn't already started.
Quantitative Easing (QE) is a very effective tool in a big crisis, such as the COVID-19 pandemic. The monetary tool helps lower rates and ease financial conditions, supporting every business that needs to borrow money for investment or refinance, encouraging business owners to retain employees, and potentially hire more. However, as a crisis begins to ease, the efficacy of QE is questionable, especially as it relates to the Fed's dual-mandate of price stability and maximising sustainable employment. Given current CPI data, it's reasonable to say the Fed has fulfilled its inflation target. Leaving aside the debate about QE's ability to create the 'right' jobs, one can also argue that the Fed has fulfilled its job creation mandate. There are currently 11m job openings in the US, comfortably more than the 6m required to get the US unemployment rate back to pre-COVID levels.
With ample job openings, inflation well ahead of target, financial conditions that are certainly not tight and strong economic growth, the obvious question is what does the Fed need to see to finally start tapering its asset purchases? If they wait too long, the market becomes conditioned to QE, and any tapering will tighten financial conditions. From our perspective, this is a scenario the Fed needs to avoid, but they are in danger of falling behind the curve if they haven't already.
Over the last few months, the prevailing economic conditions in the US seem to fulfil the criteria for tapering to begin, even acknowledging the complicating factor of the increase in the Delta variant. In our view, by delaying further, the Fed is risking a policy error. Moreover, the Fed's hesitancy leads us to question what conditions need to prevail for the rate rising process to start – does goldilocks even cover it?
If the Fed doesn't announce the beginning of the tapering process at its September meeting, the next opportunity to do so isn't until November – the Fed is walking a fine line.