Jerome Powell testimony may soothe frayed market nerves

In his testimony, Jerome Powell has largely pinned the blame for inflation on the temporary supply bottlenecks for almost all products ranging from food to minerals to ores to microprocessors.

June 23, 2021 3:05 IST | India Infoline News Service
On 22 June when Jerome Powell gave his testimony on the Fed statement, 3 things stood out crystal clear. Firstly, inflation was more likely to be temporary than structural and that assumption would drive Fed policy. Secondly, economic pain was sharper for the more vulnerable sections and hence any liquidity benefit withdrawal would be gradual and phased. Last, but not the least, Powell underlined that even if inflation was elevated and GDP growth was robust, rate hike decision would only be clinched by a sharp improvement in job creation. It was the third point which proved to be music for the global markets.

Chart Source: Trading Economics

Powell believes inflation spike will be temporary

One of the highlights of Powell’s testimony was that the current price hike was temporary. As can be seen in the chart above, the rate of inflation has spiked from 2% to nearly 5% since the recovery began in mid-2020. One view is that the spike in inflation is a direct outcome of Joe Biden’s aggressive $1.9 trillion economic relief package. That apparently created a situation of too much money chasing too few goods and services leading to an automatic spike in inflation.

In his testimony, Jerome Powell has largely pinned the blame for inflation on the temporary supply bottlenecks for almost all products ranging from food to minerals to ores to microprocessors. In fact, Powell specifically emphasized in his testimony that most of the inflation gains came from soaring prices of used cars, flight tickets and hotel rooms. According to Powell, essentially the demand has revived but supply is struggling to keep pace; creating this supply chain bottleneck.

The Fed Verdict appears to be that high inflation should sober with the supply chains loosening and supply catching up with demand. Hence it is hardly a structural worry. Powell feels such imbalances that caused inflation should rectify in auto mode, without any intervention. The only intervention required is to keep the policy accommodative till then. For now, the verdict is that inflation should revert to the range of 2.0% to 2.5% by next year.

Growth strong on vaccine effect, but recovery distribution uneven

The second significant area of focus has been growth in GDP. Due to a combination of monetary and fiscal support, real GDP is growing at the fastest rate in decades after 6% last quarter. However, Powell has asked to be cautious about any bounce from extreme pessimism, which is what happened post-COVID. In this light, there are two important points that Powell has made.

Firstly, the growth is largely on account of the vaccination effect and the pace at which the US managed to vaccinate the population. Secondly, and very significantly, Powell pointed out that there was a story beyond the headline number and that referred to the evenness of growth. Apparently, like in any economic crisis, the vulnerable segments of the population have taken a larger share of the stress. Hence, that segment would be the benchmark for the Fed to take any view on tightening.

Fed will not tighten unless job situation improves

If there was one message from Powell, it was that the clinching argument would pertain to jobs. The inflation-jobs chart shows that the unemployment rate has fallen sharply since the peak of the COVID crisis from 15.3% to 5.8%. However, the important point underlined by Powell was that they would prefer to wait till the original Fed target of 4.5% unemployment, what the US government defines as full-employment situation.

Powell’s contention, and rightly so, has been that those least able to shoulder the burden of the crisis have been the hardest hit. Hence, joblessness would be a better barometer than GDP growth to give a more equitable picture of the recovery. More than rates, this statement of the Fed has implications for liquidity and economic support.

Powell has committed that the support to prevent businesses from shuttering will continue for now so as to prevent job losses and demand destruction. He also added that the backstops in the credit market would continue till smooth credit was available to people. Lastly, Power underlined that while the CARES Act support had closed, Fed support would continue to families and business till the economic recovery was credible and backed by jobs data.

Takeaways for global markets

There are 3 key takeaways from Powell’s testimony. Firstly, since labour improvement proves to be sticky, the tightening of liquidity and rates may happen later than estimated. Secondly, the world does not need to bother about a sudden disruption in liquidity. Any liquidity disruption would be gradual; and at least not in the foreseeable future. Above all, the therapeutic tone of Powell indicates that the Fed does not want to be seen as the central bank responsible for shutting the liquidity taps, like in 2016. It looks like status quo through 2021 and most of 2022 and that could be the good news for markets.

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