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New COVID variant adds uncertainty for a Fed in the process of slowing support

The emergence of a new COVID variant spooked markets on Friday, forcing some Fed watchers to question if the Federal Reserve will change course on its plans to slow its monetary support to the U.S. economy.

“Policy normalization already looked like it was going to be gradual but the... growth worries we're seeing come back into the market’s consciousness in the last 24 hours could mean that monetary policy needs to be a little bit more dovish than that,” HSBC Asset Management Chief Global Strategist Joe Little said on Yahoo Finance Live (video above).

The Dow Jones Industrial Average tumbled as much as 1,000 points in holiday-shortened trading on Friday after South African scientists detected a new variant of COVID-19. Concerns over the transmissibility of the new variant led the World Health Organization (WHO) to convene an emergency session.

Federal Reserve Board Chair Jerome Powell listens during an announcement on November 22, 2021 in Washington, DC. (Photo by Alex Wong/Getty Images)
Federal Reserve Board Chair Jerome Powell listens during an announcement on November 22, 2021 in Washington, DC. (Photo by Alex Wong/Getty Images)

Earlier this month, the Fed's policy-setting committee announced it would start to pare back its purchases of agency mortgage-backed securities and U.S. Treasuries, which it had been absorbing at a pace of about $120 billion a month since the depths of the pandemic.

The Fed has begun slowing that process by about $15 billion each month, which would bring the so-called quantitative easing program to a full stop by the middle of next year.

However, a particularly dangerous variant would not align with recent signals from policymakers that they could speed up the taper process, which in turn would more quickly give the Fed the optionality to eventually raise interest rates from near-zero.

“If things continue to do what they've been doing, then I would completely support an accelerated pace of tapering,” San Francisco Fed President Mary Daly told Yahoo Finance on Tuesday.

People wearing protective face masks, amid the coronavirus pandemic, walk through Times Square in New York City, November 22, 2021. REUTERS/Shannon Stapleton
People wearing protective face masks, amid the coronavirus pandemic, walk through Times Square in New York City, November 22, 2021. REUTERS/Shannon Stapleton

Expectations for a faster taper have ramped up, as have forecasts for the amount of rate hikes in 2022. Before Thanksgiving, Fed funds futures markets priced in a 31% chance of three 25-basis point rate hikes next year.

During Friday’s variant-induced market sell-off, those odds fell to 25%.

In a note on Friday, Fed watchers at Evercore ISI cautioned that it may be too soon to say if the B.1.1.529 will force the Fed’s hand into backing off a more aggressive pullback in its monetary stimulus.

“[O]ur initial knee-jerk reaction is to think that the new variant does not make much difference to prospects for accelerated tapering — which we view as the base case — but might help the Fed distinguish between accelerated tapering and prospects for early rate tightening,” Evercore ISI’s Krishna Guha wrote.

The Fed’s next policy-setting meeting is scheduled for Dec. 14 and 15.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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