Markets Expected to Sustain Record Rally Despite Fed Tapering

By Andrew Moran
Andrew Moran
Andrew Moran
Andrew Moran covers business, economics, and finance. He has been a writer and reporter for more than a decade in Toronto, with bylines on Liberty Nation, Digital Journal, and Career Addict. He is also the author of "The War on Cash."
November 4, 2021 Updated: November 4, 2021

New Analysis

The Federal Reserve finished its much-anticipated two-day November Federal Open Market Committee (FOMC) policy meeting on Nov. 3. The results were everything financial markets had anticipated, market strategists said.

Later this month, the central bank confirmed, the Fed will begin tapering its $120 billion-per-month asset-buying program, with plans to wind down the pandemic-era quantitative easing program by next summer. The U.S. central bank also plans to remain “patient” on red-hot inflation as it wants to “see the labor market heal further.”

The Fed’s announcement, and Chair Jerome Powell’s subsequent remarks, didn’t rattle equities. So what does this mean for the broader financial markets and U.S. economy moving forward?

Rate Hikes Coming Sooner to Fight Inflation?

The FOMC agreed to leave interest rates near zero as the economic recovery marches toward its objectives. But could it raise rates earlier than policymakers penciled in?

Powell fed
Federal Reserve Chairman Jerome Powell testifies during a House Financial Services Committee hearing on Capitol Hill in Washington, on Sept. 30, 2021. (Sarah Silbiger/Pool via AP)

Powell conceded that inflation will last “well into next year,” adding that “if a response is called for, we will not hesitate.” By trimming its massive bond-buying campaign, Powell purported that this gives the Fed more flexibility to fight higher inflation.

“Inflation is elevated, largely reflecting factors that are expected to be transitory,” officials said in the statement. “Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.”

Despite increasing consumer and producer prices, the Fed insisted on using the term “transitory” in its statement.

Many market analysts expected the central bank to scratch out the word, suggesting the doves are still in charge, wrote Paul Ashworth, chief U.S. economist at Capital Economics.

“The Fed unveiled its QE taper today, as widely expected, but is still insisting that the surge in inflation is ‘largely’ transitory, which suggests the doves still have the upper hand,” he said in a note.

U.S. annual inflation is at 5.4 percent, the highest in 13 years. The producer price index (PPI) stands at an 11-year high of 8.6 percent. The Fed’s favorite inflation gauge, the personal consumption expenditures (PCE) price index, has advanced 4.4 percent, a 30-year high.

If inflation doesn’t show signs of dissipating, could the Fed start thinking about policy tightening? In the Fed’s September economic outlook, half forecast a rate hike in the second half of 2022, and the other half expect rate normalization to begin in 2023. In addition, an October Bloomberg News survey of economists shows many forecasting multiple Fed rate hikes over the next few years.

Goldman Sachs economists believe that the Fed will start hiking rates in July amid lingering inflation.

Powell revealed during the press conference that continued labor market improvements could justify rate increases later next year. This might enhance the focus on the October non-farm payrolls report. Economists are predicting 450,000 new jobs and an unemployment rate of 4.7 percent.

However, Wells Fargo Securities equity analysts don’t anticipate aggressive moves on rates.

“Therefore, addressing inflation will require time, not monetary tools. We believe this is the concept that the market is latching onto, and why the equity market is rallying,” the analysts said.

According to the CME FedWatch Tool, an increase in the target rate is not slated to happen until June 2022.

Will a Market Rout Occur?

The U.S. bond market was mostly in the green midweek, with the benchmark 10-year Treasury yield topping 1.6 percent. After the news conference, the leading indexes, including the Dow Jones Industrial Average and the S&P 500, finished the session at record highs for the second consecutive session.

In the early part of the Nov. 4 trading session, equities were trading sideways, while the Treasurys were in a sea of red ink.

As the central bank begins to wind down its stimulus and relief efforts gradually, will bonds and equities face a downturn or maintain their upward trajectory since bottoming in March 2020?

Chris Iggo, chief investment officer for core investments at AXA Investment Managers, made the point in a note that monetary policymakers raising rates in a “controlled manner” without being aggressive can mitigate “the risk of a market rout.”

Since the balance sheet will continue to expand for several more months, Ipek Ozkardeskaya, a senior analyst at Swissquote, believes equities will sustain their record rally.

“The buying of bonds should come to an end sometime by mid-2022, but until that day, the Fed will continue expanding its balance sheet to record levels, and that will continue backing the inflation pressures, and the stock markets!” she stated in a research note.

“So we can comfortably expect to see the record rally in U.S. equities to extend, because a growing number of average households will be attracted to the stock markets as that’s going to be the only way to help them keeping up with inflation rising at a speed of more than 5% annually.”

Moreover, the Fed’s tapering is bullish for corporate earnings and the overall market, says George Ball, chairman of Sanders Morris Harris, because it “is a signal of economic strength.”

What’s Next for Jerome Powell?

Fed Chair Powell’s four-year term is set to expire in February. President Joe Biden confirmed to reporters on Nov. 2 that his administration will announce a nominee to helm the central bank “fairly quickly,” without going into further detail.

“I’ve given a lot of thought to it, and I’ve been meeting with my economic advisers on what the best choices are, and we got a lot of good choices, but I’m not going to speculate now,” he said.

Treasury Secretary Janet Yellen, who was the head of the Federal Reserve from 2014 to 2018, told CNBC that she thinks “Powell has certainly done a good job.”

A Bloomberg News survey of economists highlighted that 79 percent believe Powell will be renominated, although the recent news of unusual trading among Fed officials dented the likelihood. Fed Governor Lael Brainard, a Democrat, is seen as the most likely successor, with 13 percent predicting her nomination.

Some market strategists believe the chief position in one of the most powerful institutions in the world could be used for political maneuvering. Philip Marey, a senior U.S. strategist at Rabobank in Utrecht, contended that Biden could choose to tap Brainard to “appease progressives in exchange for concessions to the moderates.”

Andrew Moran
Andrew Moran covers business, economics, and finance. He has been a writer and reporter for more than a decade in Toronto, with bylines on Liberty Nation, Digital Journal, and Career Addict. He is also the author of "The War on Cash."