What is your outlook with respect to what the Fed Chair Jerome Powell reiterated about that inflation target as well as the very dovish stance? Is it on expected lines?
It was a little more reassuring than the market was expecting. They are acknowledging that inflation might overshoot near term but they are not concerned about it and they are not going to react to it because they believe that this will be temporary as people start travelling and activity resumes post Covid vaccinations. They are going to be patient and wait for the economy to normalise and employment to drop sharply. A lot of those things give people confidence that there will be no imminent rise in rates and that they are going to be very patient about it.
What do you think this does to the bond yields? While the equity market seems to have reacted quite positively, the bond yields continue to hold out quite firm and unabated?
Both the equity and the bond markets are getting used to the fact that what Fed is saying is not about keeping bond yields extremely low but about being patient about raising rates. But they are not uncomfortable if in a measured fashion, 10-year bond yields move up towards the 2% range because that is in consonance with their long-term inflation expectation or hope. I do not think the Fed is too worried about bond yields rising but as long as they do it gradually, the bond and stock markets will continue to diverge and the bond market to moderately sell off as they thrive.
Do you think the Fed is hinting at a long period of this accommodative policy?
Well yes except that there is one caveat to that. They said that they will not react to expectations of inflation but they will react to the data. They are going to be data dependent. So if there is a significant overshoot in inflation over and above their comfort level, they will have to revise and Powell was very clear that they are going to pay attention to data and not expectations of data.
So the one exception to this patience strategy is if inflation starts to actually move higher and faster and further than what they are anticipating and then what they are comfortable with, then all bets are off the table. But for now, since they are assuring the market that they are aware that inflation is coming but they think it is temporary, the market can certainly go back to rallying again and the market again will have to be data dependent. If anything looks excessive, then the question will be how quickly does the tapering start and how quickly after that do the Fed rate start hiking rates.
