Pandemic takes its toll, policy-orientation anchored to liquidity…

The FOMC meeting which concluded on July 29, kept the Fed Funds Rate, the key policy rate, anchored in the range of 0 to 0.25%. This was on expected lines. The FOMC statement clearly said, “The path of the economy will depend significantly on the course of the virus”. Apart from keeping the rates unchanged, the liquidity facility which the Fed offered to foreign central banks and international institutions has been extended to 2021. These are repo facilities that could be availed of against US treasury notes and bonds, and this would ensure US Dollar liquidity is available to entities across the world. This facility was introduced to lend support to countries which need dollars to tide over the pandemic and the related economic conditions.

The Fed policy is expected to be oriented towards a soft and accommodative stance as long as it is required, that is, until growth comes back and sustains itself for a considerable period of time. The targeting of higher inflation is also part of the agenda. The Fed is likely to move aggressively on the YCC plans given the changed circumstances in almost all states across the US. The raging pandemic has affected a larger number of people than what was expected in the early part of the epidemic. This along with the differing levels of lockdown in the different states will be a major drag on the economy as the economic activity may not be able to pick up at a pace which is required to undo the damages of the lockdown in a shorter period of time. The FOMC noted that economic activity has improved but it is still lower than the pre-pandemic levels.

In the labour market, there were layoffs at the beginning of the shutdown. But it moderated over three to six weeks, and the latest reports reveal fresh layoffs hitting employment, and close to 32 million people received the unemployment benefits. The real estate market is beset with large supplies and falling rentals. Most of the people in rented apartments are workers from labour intensive businesses hospitality and retail business. While things seem to have improved from what it was immediately after lockdown there is still time before one can see the light of the day.

The US GDP numbers released a few days back reflects the rout in the economy caused by the pandemic. Q2 GDP fell by 32.90 % on an annualized basis, the worst number ever in US history. But most of the economists were expecting a similar fall earlier. This number beats the decline witnessed at any time, be it the Great depression or the Great Recession. This, in the opinion of many economists, may take a long time for the US to come out of. All major components of the GDP like consumption, investment, government spending and exports- all declined in Q2 resulting in this fall.

In the last edition of Navigator, we had discussed the implications of the US Presidential elections on economic policy. The Fed will continue with the quantitative expansion and low-interest rate regime at least until the elections get over. The policy beyond that would be decided by many other factors gradually evolving over time. There is a feeling that since liquidity is in good supply the markets may not have to bother about any serious correction at least until the end of this year.

Policy making becomes a more delicate affair, in the light of the worsening relationship between the US and China politically, diplomatically as well as in terms of trade relationships. The US may not be able to negotiate any of the current issues that easily for a resolution as these are fundamental in nature, like the alteration of the status of Hong Kong, claims over South China sea etc. The new dispensation will have to deal with it afresh after the elections.

The EU economy is expected to contract by 7.50% in 2020, and the economic recovery in 2021 is likely to be at 6%. The quantitative measures to the tune of Eur1.40 trillion is expected to support the revival and the plan is on course for all the economies. The macro numbers for EU to be released soon will give us a clearer picture of the things to come. But the general feeling at this moment is that though some spending is already done it may be too early to expect any visible improvements in the economy. The reversal of the lockdown itself has not been uniform in the Euro countries, and this makes the picture and an objective assessment difficult.

China growth numbers for Q2 surprised all, as the number came in at 3.20%, much higher than the market consensus of 2.50%. This is after the contraction of 6.80% in Q1, which was in the aftermath of the outbreak of the epidemic. Thereafter, business and financial activity picked up. But what needs to be seen is whether this is sustainable. China’s reliance on external trade is quite high, and the continuing pandemic in territories with whom they trade makes the picture somewhat bleak. The other issues which China faces like matters relating to Hong Kong are serious and may have consequences for China in the coming days.



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