The key highlights of the testimony will give an idea of the Fed handling taper and rates going ahead.
In the midst of a volatile global situation
One of the big questions plaguing the world markets in the last few weeks has been; about the timing and quantum of taper. Of course, it quite clear by now that interest rate hikes will start, at least one year after taper commences. We can overlook that for now. At the Jackson Hole Symposium, Powell had suggested that the taper should commence by the end of 2021, in the form of cessation of fresh purchases. However, there are a lot of X-factors.
The global situation has suddenly become a lot more fluid. The Evergrande crisis has raised worries of a hard landing for China. Supply chain constraints led to unprecedented power shortages in China, UK and the EU region. US inflation is threatening to stay at elevated levels for much longer than anticipated. Above all, global supply of almost everything from oil to microchips is struggling to keep pace with demand. Amidst this chaos, the US administrative machinery threatens to come to a grinding halt if debt ceiling is not raised.
Highlights of the Janet Yellen testimony
Here are key takeaways from what Janet Yellen testified before the Committees and what it means for global macros.
- Yellen highlighted that the Consolidated Appropriations (CARES) Act had been one of the driving forces of the rapid US economic recovery. The CARES Act was designed to help with programs to help individual families, state governments and businesses.
- The CARES dole out included child tax credit payments to 60 million families, which resulted in a sharp drop in food insecurity among families and also brought children back to schools. Yellen implied that the relief plan was not open to compromise.
- Yellen also used the testimony to highlight the importance of approving the raising of the debt ceiling since the current limits were likely to be exhausted by the Treasury by 18-Oct and the US government could not afford a payment default.
- Janet Yellen underlined that the primary focus would be to expand the debt ceiling and ensure relief flows were not impacted. An obvious inference would be that anti-liquidity measures may not be considered for now.
Highlights of the Jerome Powell testimony
On the subject of tapering and rate hikes, Powell’s testimony assumes significance and he maintained a consistent stand before both the Committees.
- Powell highlighted that while real GDP recovery was palpable, there was slowdown in household spending in the months of July and August due to the lag effect of COVID 2.0. In short, GDP recovery risks still remain.
- He reiterated that unemployment falling from the current 5.2% to sub-4% would be the key trigger for monetary tightening. Powell highlighted that the pandemic had clearly weighed on employment growth which would only stabilize later.
- The spike in inflation above 5% was a disruption caused by supply chain constraints and could not be considered as the base for policy, according to Powell. He expected inflation to fall back to 2% once the supply constraints were addressed.
- To integrate his ideas, Powell clarified that the Fed would use its tools of tightening only if fall in unemployment to below 4% was combined with a rise in sustainable inflation. That does not look likely for the time being.
- Formerly, Powell focussed only on jobs and inflation as necessary conditions. Powell has now added the commitment to promote stability of the financial system. Any taper action looks unlikely till Evergrande, EU power crisis and the debt ceiling are sorted out.
- The most important part of the testimony was that the Fed would continue to add to accommodation till the middle of next year. That virtually rules out any tapering by the end of 2021, as originally anticipated.
- On interest rate hikes, Powell back-ended such hopes and imposed stringent conditions like sustained high inflation, full employment and reduction in disparities. The testimony has tried to make tightening a lot tougher.