People walk past the Federal Reserve building on March 19, 2021 in Washington, DC.

Olivier Douliery | AFP | Getty Images

The Federal Reserve is facing a big summer as the markets look for clues as to when the ultra-light policies put in place during the pandemic may finally wind down.

Investors got their first lead this week when there was a discussion in the minutes of the central bank’s last political meeting with some members saying it would soon be time to talk about withdrawing at least one of the main tools the Fed controlled the economy.

The critical part of the meeting’s summary released on Wednesday noted that “a number of participants suggested that it might be appropriate to begin discussing a pace adjustment plan at some point in the upcoming meetings if the economy continues to move rapidly towards the objectives of the committee. ” of asset purchases. “

To the ears of the market, the passage sparked talk of “tapering,” a word that generally makes investors nervous as the Fed begins to cut back around $ 120 billion in monthly bond purchases. This program, also known as quantitative easing, is a linchpin for markets that have risen and fallen with the size of the central bank’s balance sheet for more than a decade.

Fed officials have promised many warnings before the actual taper occurs. Hence, the presence of such a conversation at the April meeting likely sent the first signal that a reduction in the purchase price was on the table. More information will be available in the coming months.

“Everyone knows that the critical phase will be here by autumn,” said Jim Paulsen, chief investment strategist at the Leuthold Group.

Market consensus is that between now and the August central bankers meeting, the Fed will start dropping breadcrumbs at its annual Jackson Hole, Wyoming symposium presented by the Kansas City Fed.

That process has already begun: Robert Kaplan, president of the US Federal Reserve in Dallas, said Thursday the rejuvenating conversation should start “sooner rather than later,” and Patrick Harker, president of the US Federal Reserve in Philadelphia, used the same phrase on Friday to describe its location.

A brief history of rejuvenation

The highlight of Jackson Hole will be the keynote address by Chairman Jerome Powell, who used the event last year to highlight a groundbreaking new policy path for the Fed’s approach to inflation.

This year, Powell is set to ease expected accelerated pricing pressures above the Fed’s 2% mandate, which has led market pressures to at least tighten policy a little to avert future problems.

“I’m not sure the Fed has much to do [tapering]although I probably would, “said Paulsen.” I would be tapering off anyway because I don’t see the benefit of having all that excess liquidity out there now. If it doesn’t create runaway inflation, then it really does nothing. Why should it hang out? “

Markets reacted negatively to the Fed’s tapering signal but have since changed course.

Commodity prices were largely lower for most of 2021, while government bond yields also fell. The sell-off on the stock market was brief on Wednesday and stocks rose on both Thursday and Friday.

These steps consoled that a rerun of the 2013 “Taper Tantrum” may not be on the cards.

In fact, that year the tantrum wasn’t even a major tantrum.

After then Chairman Ben Bernanke made comments during a congressional hearing that purchases were about to be reduced – the eighth anniversary is Saturday – the benchmark 10-year government bond yield rose a full percentage point over the next four months.

The S&P 500 gave up 5% before turning around and actually ended the year with what is still the best profit of the 21st century. Both stocks and bonds moved before the Fed actually cut the rate of their purchases at a pace of just $ 10 billion a month.

“The 2013 ‘Taper Tantrum’ happened before anything actually ‘happened’,” said Nick Colas, co-founder of DataTrek Research, in a note earlier this week.

Because of this, finding the right communications part is critical for Powell and the Fed, and why they are likely to soon set the table for a modest cut in purchases.

A possible calendar

Central bankers have so far stuck to a script that says the recent spike in inflation will last a few months and then subside. The success of how they manage to reverse the massive easing introduced since March 2020 crucially depends on the economy story unfolding in this way.

“I think the Fed will get it right because it agrees with our view that the upside risk to inflation is temporary,” said Alejandra Grindal, chief economist at Ned Davis Research.

Grindal expects the Fed to announce its tapering intentions between Jackson Hole and the November Federal Open Market Committee meeting. This schedule is a little later than other central bank observers anticipated, but broadly in line with the move this year.

“Then we expect the rejuvenation to begin in 2022. It will take about a year for the Fed to go through the rejuvenation process. After that, we expect a rate hike in 2023 at the earliest, but it could still be until 2024.” ” She said.

Economists and most Wall Street strategists accept the Fed’s presentation that inflationary pressures, which pushed the consumer price index up 4.2% in April, are likely to ease once supply chain problems and base effects subside from 2020 onwards.

However, concerns remain whether the central bank will be able to make a soft landing on stimulus that saw policy rates come back to near zero and add nearly $ 4 trillion to the Fed’s balance sheet.

The last time the Fed tried to reduce its asset holdings and raise interest rates, the results were not good. Statements by Powell that the balance sheet deduction was due to “autopilot” and that the Fed was still a long way from stopping the quarter point hikes recorded in 2017 and 2018 sparked turmoil in the markets as economic growth slowed .

That adds even more to the communication effort this summer.

“You haven’t done things perfectly in the past,” said Grindal. “The Fed is learning from the past.”

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