A screen shows US Federal Reserve chair Jerome Powell speaking as a trader works on the floor of the New York Stock Exchange on August 27. Photo: Reuters
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
US Federal Reserve’s balancing act on tapering risks is pleasing no one
Powell’s ‘tapering is not tightening’ strategy has cheered financial markets and so far eased fears of a repeat of 2013’s ‘taper tantrum’
By trying to please those who fear it might move too quickly as much as those who fear the opposite, the Fed could end up disappointing everyone
Spare a thought for Jerome Powell. As the head of America’s central bank – the world’s monetary guardian in all but name – the chairman of the US Federal Reserve has the toughest job in global finance.
Not only must Powell build a consensus on how best to fulfil the Fed’s dual mandate of price stability and full employment – objectives that have become much more difficult to reconcile since the Covid-19 pandemic erupted – he has to maintain the confidence of international investors, who are hypersensitive to shifts in Fed policy.
That Powell’s future at the Fed is uncertain adds to the pressure on the world’s top policymaker to devise a credible strategy for withdrawing monetary stimulus. US President Joe Biden will soon announce whether he will reappoint him for a second four-year term starting in 2022.
The challenge is particularly daunting, given the opposing forces at play in the US economy. Rapidly-building inflationary pressures threaten to be more persistent than the Fed anticipates, coupled with economic scarring from the pandemic that has put 6 million more Americans out of work since the virus struck.
The Fed is also determined to avoid another policy-induced shock akin to the “taper tantrum” in 2013. This is why Powell has opted to steer a middle path in dialling back monetary support, one that seeks to differentiate between curtailing asset purchases and raising interest rates.
When he spoke at this year’s virtual Jackson Hole symposium in Wyoming last Friday, he tried to delink tapering from tightening. Powell said the timing and pace of the reduction in asset purchases was not “intended to carry a direct signal regarding the timing of interest rate lift-off”.
While the Fed met the first of its two conditions for scaling back its bond-buying programme – achieving an average inflation rate of 2 per cent – some time ago, the second requirement of maximum employment is still far from being satisfied. This allowed Powell to signal that, while asset purchases will begin to be pared back at the end of this year, a rise in borrowing costs is still some way off.
Not surprisingly, the Fed’s “tapering is not tightening” strategy has cheered financial markets. The reaction on the part of bond and equity investors is one that would normally be associated with a cut in rates.
Judged solely on the basis of whether it allayed concerns about a repeat of the 2013 tantrum – which stemmed mostly from exaggerated fears on the part of investors, particularly in emerging markets, that the Fed’s withdrawal of stimulus would be quickly followed by an increase in rates – Powell’s address has so far proved a masterstroke.
Yet, convincing markets that the Fed is not in a hurry to raise rates was the easy part. The real challenge for America’s central bank is gradually scaling back stimulus at a time when there are increasing signs that global growth is slowing and when inflationary pressures continue to build.
While previous tilts towards tighter policy occurred when growth was accelerating, the current shift is taking place when economic activity in the United States and in other countries is slowing amid the fallout from the rapid spread of the Delta variant of Covid-19. Some of the regional Fed economic forecasting models show a slowdown in the third quarter.
What is more, investors are less bullish on the prospects for the world economy. In Bank of America’s latest fund manager survey, published on August 17, expectations for global growth fell to their lowest level since April 2020. If the outlook deteriorates further, markets might be less inclined to distinguish between tapering and tightening.
On the other hand, if the surge in inflation proves longer-lasting than policymakers and most investors anticipate, Powell’s efforts to dissociate the two stages of more restrictive policy will be even more difficult to sustain.
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China’s economy rose 7.9 per cent year on year in the second quarter of 2021
China’s economy rose 7.9 per cent year on year in the second quarter of 2021
Although much of the increase in prices appears to stem from transient factors – notably supply chain bottlenecks – pandemic-induced disruptions are proving more persistent than many expected. The longer they last, the more likely it is that inflation filters into wages, especially if recent increases in earnings in lower-paid service sectors begin to move up through the pay scale.
The nightmare scenario for the Fed is that the current virus-driven growth scare intensifies just as inflationary pressures become more acute, fuelling concerns about stagflation.
Such a bleak economic environment is highly unlikely. Powell is right to proceed cautiously, given the uncertain outlook. Yet, by trying to please those who fear the Fed might move too quickly as much as those who worry it is moving too slowly, he could end up pleasing no one.
