New COVID variant spokes market, raises questions whether the Fed will change course

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New COVID variant spokes market, raises questions whether the Fed will change course

On Friday, the emergence of a new COVID variant spooked markets, forcing some Fed watchers to question whether the Federal Reserve will change its 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 developments we see, 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, according to HSBC Asset Management Chief Global Strategist Joe Little on Friday after South African scientists detected a new variant of COVID- 19 in holiday-shortened trading. Concerns over the transmissibility of the new variant led to the World Health Organization WHO convening an emergency session.

The Fed's policy-setting committee announced earlier this month that it would start to reduce 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 epidemic.

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

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

If things continue to do what they've been doing, I would fully support an accelerated pace of tapering, said Mary Daly, San Francisco Fed President.

Expectations for a faster taper have gone up as have the projections for the amount of rate hikes in 2022. The Fed funds futures markets priced in a 31% chance of three 25 basis point 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. 529 will force the Fed s hand to back off a more aggressive pullback in its monetary policy.

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 spokesman Krishna Guha wrote.

The Fed's next policy-setting meeting is scheduled for December 14 and 15.

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