The world markets were waiting with bated breath for the announcement of the non-farm payroll data from the US. The data was thought to be a critical input for the US Federal Reserve to make up its mind if it was time to reduce the large amount of bond-buying being undertaken every month.
The Jackson Hole commentary of Fed Chair Jerome Powell indicated a broad agreement that the US economy had progressed well and a reduction in the bond-buying was justified.
But, the speech fell short of laying out a timetable. The Fed probably wanted to buy some time to analyse the economic impact of the Delta variant on the US economy. Justifiably so. Recent reports indicate that hospitals in Florida, South Carolina, Texas and Louisiana are struggling with oxygen scarcity, driven by a large number of people who remain unvaccinated with the variant infecting hundreds of thousands of Americans.
The data flow has been mixed, a likely situation whenever inflection points are reached and especially when the economy is fighting an unknown devil–coronavirus that has played mischief by mutating and creating uncertainty.
The August report indicated that employment underperformed (payrolls rising by only 2,35,000 when the market was expecting around 7,50,000), but the earnings (solid at +0.6 percent MoM) and the average weekly hours worked (very healthy 34.7) remain strong.
Employment gains in the private sector were in line with recent trends, while the bar for workers to return to work in the contact-intensive services is still quite high.
Offsetting some amount of disappointment in the headline employment numbers for August, there was an upward revision in the previous month’s data by 1,34,000.
The inflation confusion
The other guiding factor for the central bankers to gauge the extent of lift-off in economic activity is inflation. Here the script for the Fed and many central bankers across the world remains confusing.
The struggle is to figure out if the high inflation of today is due to supply-side constraints that are biting or whether there is an element of demand-side pressure.
Powell at Jackson Hole continued to indicate that the inflation surge is temporary and importantly, highlighted that the global “disinflationary” forces that prevailed over the past 25 years are simply not going away. “It seems more likely that they will continue to weigh on inflation as the pandemic passes into history,” he said.
This is also the reason why most central bankers are looking at a flexible inflation targeting mechanism that will provide them with some wriggle room in the light of inflation remaining stubbornly high.
The confusion at the central banks across the world is thus apparent. With uncertainty about the virus and its spread, no one can be sure about the timing of the reversal of the monetary policy.
Prepare for taper
Central banks, thus, are likely to risk a delayed tightening, lest they make a mistake by tightening early and killing the nascent recovery process. But then how late is too late? In that event, the tightening process may have to be faster and this can shock the markets, thereby again leading the economy to slow down.
Central banks can do the next best thing—prepare the markets for change to prevent the surprise and shock element. And this is what the US Fed is probably trying—sensitising financial markets of the need to ultimately move away from Covid-19 induced monetary easing. This will specifically start with withdrawal of liquidity but rate tightening is way off.
Powell clearly indicated that the standards for rate hikes are more stringent. We think that rates hikes may be way off into CY2022 or even early CY2023.
The Reserve Bank of India (RBI) can breathe a bit easy. Even as the RBI governor indicated that monetary policy in India would be based on domestic conditions, financial markets in emerging economies would be affected if the US Fed curtail its bond-purchase programme. But the impact is unlikely to be as heavy as the “Taper Tantrum” days of 2013 when India was struggling with both a fiscal and current account deficit and the forex reserves were relatively low.
Today, the RBI has managed to amass $572 billion worth of foreign currency assets that will be handy in fighting any speculative attack on the rupee, consequent to a reduction in the bond-buying by the US Fed.