FOMC statement hints at taper by 2022, rate cuts by 2023

Here are key takeaways from the FOMC statement issued by the Federal Reserve on 28 July.

Jul 29, 2021 09:07 IST India Infoline News Service

On 28 July, when the Fed policy was announced by Jerome Powell, there was not much of a reaction either on the CME Fed watch tool or in the US the bond yields. The 10-year bond yields trended lower to 1.24% while the CME Fed watch tool continued to hint at 2 rate hikes by 2023. However, the timing of taper and rate hikes continue to be uncertain for the time being. Here are the key takeaways from the Fed statement.

Key takeaways from the FOMC statement Jul-21

Here are key takeaways from the FOMC statement issued by the Federal Reserve on 28 July.

• At a macro level, Fed has given a rather emphatic signals that it had begun the process of scaling back its massive monetary support for the American economy. However, the statement continued to be ambiguous about the pace and timing of the taper or the rate hikes.

• The Fed clarified that there would be no change in its bond buying program of $120 billion per month consisting of $80 billion of treasuries and $40 billion of mortgage securities. In Dec-20, Fed had underlined that it would not commence winding down the bond-buying program until “substantial” progress was visible in its unemployment and inflation goals.

• Interestingly, on Wednesday the Fed did hint that the American economy has made progress toward these goals of low unemployment and stable inflation. Analysts interpreted the statement as the first official affirmation from the Fed that the US economy was making progress towards the goals. Powell indicate that there were elaborate discussions on how and when to taper. Clearly, there would be more insights in the minutes of the FOMC meet.

• The FOMC statement indicated that while inflation was running ahead of the Fed annual inflation target of 2%, they are keen to see inflation at high levels after discounting the effect of commodity price inflation and price spikes driven by supply chain constraints. On the jobs front, Fed expressed concern that there was still a huge unfinished agenda of filling up millions of jobs lost in the pandemic.

• On the inflation front, Powell reiterated his concerns that the inflation spike may not be sustainable. According to Powell, higher inflation effect may be largely transitory and merely tied to the reopening of the economy where surge in pent-up demand overwhelmed manufacturers and drove cost of supplies and labour higher.

• Powell had an interesting take on the Delta variant and did not appear overly concerned. He felt that between COVID and COVID 2.0, the US and the world were better prepared. Hence, the economic impact of COVID 2.0 was limited. He expects a similar outcome on delta variant too. However, Powell cautioned that one cannot underestimate the potential impact of the delta variant.

• Going by previous statements of the Fed, the entire decision predicates on the word “substantial progress”, which Powell emphasized time and again. Powell has reiterated that the US economy was still a good deal away from making “substantial further progress” toward the dual mandates of stable prices and maximum employment. Not surprisingly, status quo was maintained in July policy.

• Addressing queries on ad-hoc reduction of mortgage securities buying, Powell underlined that any such decision would only be synchronized with the actual taper. This clarifies that the Fed does not appear to be in a hurry to take any policy action for the time being. Powell dismissed the idea that mortgage bond buying was impacting home prices in the US.

• Many analysts are less sanguine about the tapering or low rates continuing much longer. Many view the Fed statement as setting the process of taper in motion, irrespective of when it actually happens. Fed has used the word progress towards goals rather than substantial progress, but markets are interpreting that the Fed is just softening the message and taper may be on schedule to start in early 2022 with rate cuts in 2023.

• On inflation, Powell indicated that the inflation would stay above the 2% mark in the coming months. While the rate is already above the central bank target, the Fed would wait for the inflation to remain above 2% for some time so that the average inflation comes above 2%.

• To paraphrase Powell, the Fed needs strong jobs growth to consider implementing the taper and at this point, that was missing. That would complete the definition of substantial progress of the Fed.

What does the policy statement mean for the Indian economy?

There are times when no change is good and this is one such situation. The Indian markets are prepared for a likely taper in 2022 and rate cuts in 2023. Unless the pace is quickened, there would be no negative surprise. However, the short-term impact needs to be handled. The FPI flows have been negative on strong dollar in July and that is the kind of disruption that any taper can create as it would strengthen the dollar. At a policy level, not much changes for India Inc.

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