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Key Takeaways from Senate Testimony of Jerome Powell

It was rather ironical because just as the Omnicron variant has been posing an imminent threat to the global economy and markets, Fed has underlined the need to reduce support to the economy to cool down inflation.

December 06, 2021 8:01 IST | India Infoline News Service
As is the general norm, the Fed Chair Jerome Powell and Treasury Secretary Janet Yellen, testified before the Senate Committee on Banking. This testimony is known to contain useful insights on the future trajectory of monetary policy in the United States. This is a regular feature in the US after every Fed Policy meet.

Key takeaways from the Powell Senate testimony

It was rather ironical because just as the Omnicron variant has been posing an imminent threat to the global economy and markets, Fed has underlined the need to reduce support to the economy to cool down inflation. Here are some major points emerging from the Powell testimony on the last day of Nov-21.

a) Both Powell and Yellen have signalled that the Federal Reserve could most likely front-end the reduction of support to the economy. The original schedule was that with the $15 billion taper per month, the entire $120 billion of bond buying would be wound up by Jun-22. However, the indications coming from the testimony to the Senate Banking Committee is that it could happen much earlier than Jun-22.

b) Powell has also testified that the sticky high levels of inflation could last well into 2022 and that the debate over transitory inflation was no longer the issue. The reality was that the inflation had persisted for too long to be termed as “transitory” inflation. Hence, the only policy choice in front of the US Federal Reserve was to focus on wind down the bond buying and also work out a timetable for rate hikes.

c) In a way, it is axiomatic that a sharper than expected cut in the bond buying program would suddenly suck out liquidity from the monetary system. The immediate casualty could be the equity markets with the Dow Jones index already having doubled since Mar-20. What Powell has underlined in his testimony to the Senate Banking Committee is that the liquidity driven bubble may have just gone on for too long.

d) In his testimony, Powell underlined that the central bank was worried about stubbornly high inflation. High inflation at stubborn levels means that investors are earning negative real returns on investments. This would leave millions of retired Americans with high cost of living, tepid real growth in retirement savings and the ghost of inflation lasting too long. This made faster than expected winding down of bond purchases inevitable.

e) In an important piece of testimony to the Senate Banking Committee, Powell also made the gist of the Fed stance clear. He underlined that for the Fed it was a choice between the risk of inflation and the risk of Omnicron impacting overall economic growth. Powell has emphasized that Fed was willing to live with a primary focus on inflation rather than economic growth.

f) The immediate interpretation of the Powell testimony was that he appeared a lot more hawkish than is his usual wont, considering the Omicron risk. To begin, with the indication is that the normalization of the asset purchase program could be a lot more aggressive. The logical corollary to this argument is that if the taper is completed faster, then rate hikes could start sooner and Fed could consider 4 rate hikes in 2022.

g) The most important part of the testimony by Powell was that he admitted it was time to retire the usage of the word “Transitory”. That is the first signal that the Fed is now acknowledging that even though inflation may be supply side, it was still hitting people and supply constraints were unlikely to go away in a hurry. Interestingly, it was Powell who had, all along , argued that inflation was driven by transitory forces.

What does the Fed testimony mean for Indian markets?

To begin with, the Fed testimony is perhaps the biggest affirmation of the fact that the Fed is giving up its obsession with the term “transitory inflation”. In a way, that is also the argument that the RBI has used to give preference to growth over inflation. This testimony could make RBI lean more towards inflation control than towards growth. We could see the first traces of that approach in the December 2021 monetary policy itself.

In a way, India’s approach was also fashioned by the US Monetary Policy Framework announced in September last year. However, now the Fed prefers to tighten the credit market even before the jobs situation has normalized. That is likely to see Indian monetary policy increasingly shift towards inflation control in the near future. This could perhaps mean that accommodative stance of RBI monetary policy may be phased out.

On the stock markets front, the taper scare already impacted FPI flows resulting in heavy outflows in last one month. That could be the overhang on the markets in the coming weeks.

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