The Fed Taper Is Here…Now, What About Rate Hikes?

After several months of buildup, the Federal Reserve announced last week the long-expected taper. Later this month, the US central bank will begin reducing the pace of its Treasury and mortgage-backed security purchases by $15 billion per month.

As we've suggested, the taper announcement came and went without a tantrum: the Fed, having learned from the 2013 experience, avoided a severe market reaction by making its intentions clear well in advance. If the pace of tapering is steady, as we expect, the Fed will be done with this version of quantitative easing (QE) in eight months-in mid-2022.

That's when things get interesting.

The general view, which we share, is that the Fed can't or won't raise interest rates while it's still making purchases under QE. That means the earliest it could raise rates is next summer. Indeed, the market has priced in that possibility, with the US yield curve now incorporating two 25-basis-point rate hikes before the end of 2022. That's a big change from only a few weeks ago: markets are more worried about inflation and more confident that central banks will respond aggressively to rising price pressures.