With the market reacting negatively to the surprisingly hawkish projections of FOMC members, investors had to find solace in the commentary by the US Federal Reserve Chairman Jerome Powell in the post-policy conference where he effectively told the market “don’t bother with the projections”.
Powell’s post-policy press conference provided market clarity on the central bank’s thinking and a roadmap on several issues such as the eventual tapering of record bond buying program and conditions for interest rate hikes.
Fed is now talking about talking about tapering
The most important takeaway from the central bank’s latest monetary policy meeting was the fact that Powell admitted that the central bank is now talking about the fact that it is time that it starts talking about tapering its massive bond buying program.
Currently, the Fed is buying roughly $80 billion of bonds per month, but Powell said that since members are confident on the recovery in the economy and expect the same to continue, they felt it was time to discuss bond tapering in the coming meetings.
Market folks believe that the Jackson Hole Summit could be the time when the central bank could, finally, hint at when it wants to start rolling back its bond buying, which may put emerging markets like India up for some volatile months going ahead.
Powell suggests don’t bother with hikes
While FOMC’s members’ median projection is now predicting two rate hikes in 2023, Powell said that markets should take the projections with a “big grain of salt”.
“Dot plots are not a great forecaster of rates. We did not discuss on lift-off (of interest rates in the meeting), any lift-off discussion will be highly premature,” Powell said in the post-policy press conference.
Yet, Powell also highlighted that he aligned with the member’s projection that the full economic recovery will be achieved much before they had anticipated.
Conditions for Fed’s lift-off
That depends on two conditions. Firstly, Powell said that if long-term inflation expectations in the economy move materially higher than the central bank’s long-term average of 2 per cent then the Fed won’t hesitate to use its tools (read lift rates). Secondly, it will depend on how the FOMC members define “substantial further progress”. Powell said that while Fed is more confident in the recovery now, the economy is still “ways off substantial progress”. However, what is noteworthy is that the FOMC has decided to start assessing progress from next meeting onwards.
Inflation may not be that transitory
The great debate in the global markets since the March Fed meeting has been the Shakespearean question of whether inflation is transitory or not. In the rapidly re-opening American economy, inflation has run hot in April and May. Powell maintained that the Fed sees the near-term inflation to be transitory as they expect CPI to drop in 2022. On the other side, Fed members expect a very strong labour market in the long-term to push inflation here beyond 2023, which will provide conditions for the central bank to lift rates. Perhaps, the Fed is leaning more towards a not-so-transitory inflation.
Volatility may spike for EMs
Fed’s intention to shift the tone of the policy toward a post-pandemic era a little sooner than most expected them to could cause some precipitation for emerging market investors in the coming six months, especially, as the market prices in the possibility of Fed starting its bond tapering by December. Volatility could also come from currency market as signs of policy tightening could feed into a rebound for the US dollar. There are already signs that the strong run in the EM currency basket is losing its steam.
