What the Fed said and what the Fed is likely to do?

In the Fed statement and in the post announcement interview by Jerome Powell, what emerged is that the Fed doesn’t believe the economy is strong enough to take away bond buying for now. Fed did make a rather ambiguous statement that the “Tapering may soon be warranted.”. It is not clear how soon the tapering will be warranted. It is also not clear how soon the Fed would act once tapering was warranted.

Sep 23, 2021 02:09 IST India Infoline News Service

In policy making, it is believed that what is perceived about what you say is more important than what you say. Therefore, when the policymakers want to keep the policy open-ended, the language is deliberately kept ambiguous. That would perhaps best describe the latest Fed statement issued on 22nd September after conclusion of the FOMC meet.

Economy still not strong enough

If one were to sum up the gist of the announcements made by the Fed chair, Jerome Powell, it is that the US economy was not strong enough to warrant tapering of the asset purchases. Currently, the Fed is purchasing government bonds worth $80 billion a month and mortgage bonds of $40 billion a month. Tapering first entails stopping the fresh bond purchases and only renewing existing bond buys. The next step will be to lighten the balance sheet overall.

In the Fed statement and in the post announcement interview by Jerome Powell, what emerged is that the Fed doesn’t believe the economy is strong enough to take away bond buying for now. Fed did make a rather ambiguous statement that the “Tapering may soon be warranted.”. It is not clear how soon the tapering will be warranted. It is also not clear how soon the Fed would act once tapering was warranted.

Indecision is also a decision, in this case

While the global markets were not expecting any outlook on rate cuts, it was expecting timelines on the taper. The markets were expecting taper to start in December this year, but November may be too late to give an outlook on December Taper, so most likely the taper will be put off to next year. In a way, the Fed has decided to be indecisive. There are two important macro reasons for the same.

Firstly, the Evergrande crisis has just started to unfold and the global markets are already jittery expecting a contagion effect. While the timing of the crisis may have come too late to impact the Fed Dot Plot chart, it has forced the Fed to build an escape route into its language in case the Evergrande crisis snowballs.

Secondly, the US debt ceiling comes up for review in October and while the Democrats have majority in both houses, they have been trying to pin the blame on Trump. Till the debt ceiling issue is resolved and the $3.5 trillion infrastructure investment is passed, the taper or rate hikes are unlikely to happen.

Economy, inflation and labour conditions are the key issues

In his post Fed interview, Powell highlighted that the economy was still not out of the woods. Essentially, his hint was that while the GDP was reflecting solid revival, the revival in median personal incomes was still not visible. The recovery had been still too unbalanced and in many cases, even ethnically unfair.

That brings us to the second issue of inflation. Headline inflation was up 5.3% and core inflation was up 4% in August 2021. That is well above the inflation target of 2% and has consistently held above that rate. Even though the dovish members of the FOMC have hinted at inflation being transitory, there is almost a consensus among members that inflation did make a case for tapering and rate hike.

The big roadblock to a taper and rate hike remains the labour data. Unemployment remains at 5.2%, against 3.5% prior to the pandemic. That indicates millions of lost jobs or missing consumer demand. The Fed has already clarified that even through taper may happen soon, rate hikes are unlikely till the time the joblessness remains above 3.5%. That is going to be a very tough target to achieve.

Has “substantial further progress” been achieved?

Let us leave aside rate hikes for the time being and just look at the taper. The condition was substantial progress on GDP growth, inflation and jobs. While the substantial progress has been made on GDP front and inflation front, there are risks that the Fed chair sees in going overtly hawkish at this point of time.

For example, unemployment rate declined by 0.2% and employers only added 235,000 workers in August against expectations of 10,00,000. Weak job creation was pronounced in COVID sensitive sectors like retail, leisure and hospitality. Also, the 7-day moving average of COVID-19 cases spiked from 16,000 in June to over 100,000 in August. Despite higher inflation, rate hikes are unlikely to happen till these issues are resolved.

Why this is good news for India?

With no decision in the Sep-21 Fed meet, the next meet is scheduled only in November. It may be too late to attempt a 2021 taper, so it looks like taper would move to 2022. That means, the liquidity flows into India will continue to remain robust. Also, the hints of rate hikes getting back-ended has pushed down US yields. That has actually spurred debt market flows into India and that is likely to continue. The global markets got the much-needed dose of stability in the midst of the volatility created by Evergrande!

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