Tapering Begins This Month, But Rate Path Depends on the Economy

U.S. monetary policy is now entering a tightening phase as the Fed issued their official statement following their seventh meeting of 2021. As expected, the Fed announced that tapering would begin this month. We know now that tapering will proceed, but the process is expected to precede rate increases. At this point, rate increases are not likely at least until the second half of next year.

This November meeting’s official statement had much more change in language than prior statements have seen. While also affirming their view that inflation has been transitory, they acknowledged that supply and demand imbalances have contributed to sizable price increases in some sectors. The Fed remains optimistic and believes that… “Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation.”

The taper plans were announced, but its exact course could change based on what happens with progress toward full employment as well as what happens with inflation. As it stands, tapering would end by mid-2022 and rate increases could begin then, but no plans for rate changes were communicated.

The Fed did not provide new rate dot plots from Fed officials, which map out policymakers’ expectations for where interest rates could be headed in the future, so the timing and path of assumed rate increases are uncertain. At the September meeting, the median participant’s view was that the first rate hike would happen before the end of 2022. In September’s view, 9 of 18 officials expected at least one rate increase before the end of 2022, and three saw at least two increases by that time.

The financial markets are projecting at least two rate increases in the second half of next year. Chairman Powell was asked about this view in the press conference, and he said the focus currently is on tapering first. He said, “The timing will depend on the path of the economy.”

Bond yields moved higher to end the day after the financial markets digested the new information. Yields are currently about 10 basis points lower than the October peak, but that peak was lower than the highs reached in late March and early April.

Consumer loans like auto loans and mortgages are more directly related to these longer-term yields rather than the Fed’s short-term rate policy. The 10-year yield is up 84 basis points year over year. However, consumer rates on auto loans have not moved up so far this year as yield spreads on auto loans have narrowed.

As spreads have narrowed to be more in-line with spreads prior to the pandemic, most borrowers have seen lower rates even as bond yields have been higher year over year. The auto market has enjoyed stable and favorable credit trends all year, but moving forward we’re likely past the lowest of the lows, and going forward the year-over-year comparisons will start to turn unfavorable.

Average auto loan rates moved lower in October but have started November moving slightly higher. It is likely that consumers will continue to see relatively low rates and favorable terms at least until the Fed is driving rates higher. However, bond yields can move ahead of the Fed, so credit conditions could change more rapidly if indeed the path of the economy ends up differently than the Fed is currently expecting.