Federal Reserve (Fed) Chair Jerome Powell stressed that the November 3 Federal Open Market Committee (FOMC) meeting was more about QE than interest rates. Head of Multi-Asset Paul O’Connor explains why that will change going forward and what it could mean for investors.

Key Takeaways

• As expected, the Fed confirmed that it will begin reducing its monthly purchases of Treasuries and mortgage-backed securities (MBS) at this month’s FOMC Meeting.
• The central bank can take comfort in the fact that it has managed to start tapering without a market tantrum. But from here on, the focus of FOMC meetings will likely be the Fed’s interest rate strategy.
• With central banks facing some difficult decisions in the next few quarters, we would expect equity markets to become increasingly policy sensitive and data dependent.

The Federal Reserve (Fed) confirmed market expectations at the November 3 meeting by announcing reductions in monthly purchases of Treasuries and mortgage-backed securities (MBS) of $10 billion and $5 billion, respectively. With the taper beginning in November, the current round of quantitative easing (QE) looks set to conclude around the middle of next year. While big surprises on the outlook for growth, inflation or the pandemic could alter this schedule, the hurdle to change is probably fairly high.

Fed Chair Jerome Powell was careful to separate the Fed’s actions in tapering QE from the decision about when to start raising interest rates, noting that tapering “does not imply any direct signal regarding our interest rate policy.” Neither the Federal Open Market Committee (FOMC) formal statement nor Chairman’s Powell’s Q&A session yielded much new information about the future path of U.S. interest rates. The lack of pushback against recently raised interest rate expectations encouraged investors to nudge yields a little higher, all along the U.S. yield curve. The Chairman stressed that this FOMC was much more about QE than interest rates but this will be the last meeting in which that reasoning will hold. From here on, future FOMC meetings are going to return the focus back to the Fed’s interest rate strategy and tactics.

The Fed can take comfort in the fact that the central bank has managed to start the taper without a market tantrum. However, Wednesday’s actions are only the first step down the long road toward monetary normalization. The policy challenges going forward will be formidable given the uncertainty surrounding U.S. labor market and inflation dynamics, and the appropriate scale and speed of future interest rate moves from today’s unusually low levels.

While volatility has surged in fixed income markets in recent weeks as investors have struggled to recalibrate interest rate expectations, stock markets have generally shrugged off these concerns. Equity investors have taken comfort in the fact that real interest rates in the U.S. and other major economies remain very low and that corporate earnings reports have generally remained constructive. The latter theme has been more convincing in Europe and the U.S. than in Asia and emerging markets, which continue to be overshadowed by China-related growth concerns.

Equity investors would be unwise to extrapolate recent trends too far into the future. While seasonal patterns look supportive for risk assets into year end, the outlook beyond that is unusually opaque. With corporate earnings looking set to decelerate sharply in 2022, QE coming to an end and the global interest rate cycle turning upward, some powerful tailwinds that propelled risk assets through the post-pandemic recovery are now dying down. With central banks facing some difficult decisions in the next few quarters, we would expect equity markets to become increasingly policy-sensitive and data-dependent. Attention now turns to Friday’s important U.S. payrolls data.

Taper refers to a reduction in assets purchased by the Federal Reserve.

Treasuries are instruments in monetary policy that allow central banks to sell and repurchase to control the supply of money in the economy.