Jackson Hole and After

The Jackson Hole address of the Fed Chairman raised enormous amount of interest among the investors, and the markets too. This was due to the fact that many expected the Fed Chairman to elaborate on the Fed’s plans for the future, that is about the easy money policy and the quantitative expansion through asset purchases.

The minutes of the FOMC meeting of July, made it clear that the Fed was contemplating to taper off the asset purchase programme much earlier than expected, most probably by late 2021. There are two significant aspects to this. First and foremost, the asset purchase programme itself, of US$ 120 billion per month, and second, and the substantial part, the timing of the hike in base rates. Though the initial hints from the Fed were about a tapering by 2024, it was quickly changed to 2023 and then to 2022. And now, it is most likely by late 2021. The trajectory of growth and inflation ultimately decides the course of central bank money policy. The objective of the Fed’s cheap money policy, of low rates and asset purchases, was support to asset markets, and to help people and businesses afford goods and services, so that the level of aggregate demand was kept up as high as possible in the face
of the pandemic.

However, it is also important for the central bank to keep the cost of long-term borrowing as low as possible so that the prevailing economic conditions do not affect business and industry. The rate cuts and the injection of liquidity through asset purchases helped in bringing these rates to low levels, to 0% to 0.80 % levels. Consequent to this the US economic growth suddenly picked up, and the rate of retail inflation also moved up. Under such circumstances, it may not be in the interest of the economy to continue with a cheap money policy without end. Therefore, the tapering off may start soon. Powell said, “My view is that the substantial further progress test has been met for inflation,” and that “There has also been clear progress toward maximum employment.” The US consumer prices in
August moderated a bit; the CPI rose by 5.30 % lower than 5.40 % reported for the month before the last.

This is in line with market expectations. The core inflation or core CPI also moved down to 4 % as against 4.30 % in July. The higher prices were the result of supply related issues in some of the sectors which were affected by the pandemic. Inflation has moderated but the rate of inflation is still quite high, and the inflation expectations of households also.

The NY Fed’s Survey of Consumer Expectations covers 1,300 households about their expectations for inflation and prices in categories like food, gas, housing, and education. The recent survey points towards expectations of much higher inflation in the coming months. There are a few other surveys too which reflect the expectations of inflation most likely staying above the Fed target, and this may call for policy action sooner than later. Inflation may be transitory, but it may stay high for a while and may take time to actually come down. One reason is that the pandemic affected sectors have seen higher prices in the aftermath, but there is an emerging trend that some of the other sectors as well are facing price rise.

Housing costs, medical care, recreation costs, apparel prices. There is a kind of spreading out of the price pressures into more commodities. The price developments have been quite in line with expectations. The cause of inflation is that demand is outstripping supply, and the pandemic-led supply disruptions, and the truncated ability to revive production, have caused much of this price spiral.

While we may not see the inflation rate going up from this level, it may, in all probability, sustain near around these levels for a longer time. That would be a signal for action. Tapering is invariably followed by higher rates, and this may have two specific impacts. The asset prices may start coming down, and the US Dollar may start appreciating. This may not be evident from the first response to the statement on tapering. That will gradually emerge after a while as professionals digest the statements and assimilate the intent. The market response yesterday was quite like, we
knew it all and that that it was in the coming. In the last tapering certain trends were witnessed. The emerging market currencies weakened, and the asset prices moved lower. But it may not be entirely the result of tapering that the emerging market asset prices came down. Usually, in times of accommodative policy in the US and Europe the emerging markets witness good inflows which is money chasing riskier assets and higher return. Such moneys
may move out as tapering starts. But the more important aspect of this is that the emerging market indexes continuously rally as money flows in, and the markets touch relatively expensive levels, or to put in in better terms, “fair valuation” and from such altitudes it is obvious that some corrections mayhappen. Therefore, we cannot put the blame for market corrections in emerging markets entirely to tapering. While the Fed Chairman’s statement has covered only tapering at this time it is highly likely that market rates may also start rising, and the base rate too. The observed behaviour of central banks on both sides of the Atlantic is that when it comes to cutting rates, they are slow, but when it comes to hiking rates, they act relatively more swiftly. Therefore, it is only a matter of time before the rates wouldstart rising.

Economies which are fundamentally sound, because of the consumer base and the corporate performance, like China and India, could see some volatility, but the strong fundamentals will provide the long-term anchoring for investors. More than the impact of the Fed tapering the normalization by the local central banks would be more material in this case. The RBI has already initiated the normalization with a hike in CRR to the tune of 1 % effected in March and May this year, and the Variable Rate Reverse Repos announced in the last policy.


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