Inflation worrying, but not a gamechanger
The testimony on Wednesday was not exactly smooth sailing for Jerome Powell. In fact, many of the Republican representatives wanted to know if Powell had given up on the traditional 2% inflation commitment of the Federal Reserve. The US inflation has been moderately above the 2% mark for quite a few months now, resulting in a persistent clamour for tightening the economy to prevent runaway inflation. House representatives raised concerns over the rise in core inflation items like housing, appliances, gas etc.
In his testimony, Powell pointed out that the so-called high inflation readings were confined to a small group of goods and services that were directly linked to the opening of the Indian economy. Powell expected that over the next 6 months, these prices would automatically moderate, obviating the need for any pre-emptive inflation control at this point. Powell underlined that Fed policy would, therefore, focus on pushing the US quickly towards the level of full employment, defined as 4.5% joblessness in the economy. Powell also pointed out that any knee-jerk interest rate response could spike bond yields with larger implications for borrowing costs in the US.
Economic recovery remains the primary driver
Powell affirmed in his testimony that while they were watching the price levels, recovery in the economy and a restoration of 4.5% unemployment remained the primary drivers of Fed policy. Powell pointed out that the recent jump in inflation was tied to the sharp recovery in growth and should taper with the growth tapering to more normalized levels. Hence, rather than focusing on inflation, the focus should be on allowing the growth to normalize in the regular course. Addressing the Senate Banking Committee, Powell maintained that they did not see any reason to anticipate sustained high inflation. Hence, the Fed could afford to keep its current focus on growth; and was also committed to it.
Talking about the need focus on economic recovery, Powell underlined that there were risks to overreacting to inflation, especially at a time when millions of people were still out of work. Powell underlined that inflation spike was primarily led by semi-conductors and used cars. In both cases, it was a temporary shortfall in supply, which should get rectified. Powell also pointed out that many of the high frequency data points were indicating that the economic recovery was still lopsided. The most vulnerable segments of the population were still under stress. Hence focusing on growth and waiting for supply to be restored in shortfall sectors would be the best choice at this point of time.
Bottom-line; policy action may be some time away
Clearly, the Fed chair is trying to detract from the slightly worrying signals on rates given out by the Fed rate expectations of the members of the FOMC. Powell underlined in his testimony that overreacting to the inflation spike with tightness would mean that the nascent recovery could be nipped. That could be a grave outcome, according to Powell. Hence, the $120 billion monthly purchase of bonds as well as the near-zero rates would be maintained, unless the US economy showed sure signs of moving closer to the 4.5% unemployment level.
According to Powell, nearly 6.8 million jobs were still missing, compared to the pre-pandemic situation. Any rate hike or monetary tightness at this juncture would impact supply, job creation and the fate of these 6.8 million people and their families. While inflation was a risk, it is not as big a concern as the economic recovery. Surely, it comes lower in the pecking order.
For India, this is a double-edged message
Indian markets have been closely observing the FOMC language and the Powell testimony as it has a larger bearing on Indian bond yields and the liquidity situation. The positive feature is that the US Fed is unlikely to upset the economic applecart unless the 6.8 million lost jobs were substantially accommodated. That promises a dovish monetary policy, at least till the middle of 2022, if not further.
The area of concern for India is that the US Fed policy is getting increasingly short-termist. That means; as much as the Fed can be aggressive in being dovish, it can also be aggressive in being hawkish if the data really shifted. The message for Indian government, the markets and the RBI is that they must be ready with a Plan-B. Political pressure is quite high in the US. When the economic situation changes, policy could change much faster.