FOMC,dovesandfreelunches

The event is over. The risk associated with that event is also over for now. Docile dove has become meeker and more submissive and the markets would love him.

The FOMC meeting has released their rate decision along with SEPs (summary of economic projections) like dot plots about when the rate hike is possible in future. The rates are expected to remain low and asset purchases are expected to continue till “substantial progress happens on the ground”, this was hardly an unknown but the extent of caution which the Fed chief displayed during the hour long post policy press conference came as a surprise. Positive surprise I mean for the risk on asset class.

Fed Chief Jerome Powell fielded many questions on the employment situation, inflation, dot plots, financial stability, herd immunity etc and his responses were carefully calibrated. We will try to provide our understanding of the same. First of all, the dot plots are not the committee collective assessment, they are the opinion of the individual members and hence not much should be made if some more are now seeing a hike in 2023. The median estimate remains in 2024.

The other very important message which he passed was that Fed actions will be outcome based and not expectation based. This is interesting as he followed that up by saying that any action on either a rate increase or tapering the purchase will be communicated to the market well in advance. So here are two things, first the improvement must appear in the current data not expected data and then also they will give ample time to the markets before withdrawing the easy money regime. So, if the inflation starts to shoot up let’s say in 2023, the ample warning time entails that Fed will give a year or so before acting.

Third point was on the definition of what is perceived as a data point. Inflation targeting mandates the CPI to be averaged at 2%. The Fed chief allowed the discretion to creep in there by saying that Fed will decide which inflation print has transitory elements in it and which is the permanent one. The discretion allows more leeway. On the unemployment front, he reiterated (as like in the congressional testimony) that the unemployment rate is just one of the many parameters which they follow. He stressed that there are still 10 million fewer jobs compared to pre pandemic levels. Fed would like them to return to the labour market again.

Fourth and the most important point which he made was that the US economy has entered into a low interest regime. The continued low interest rate regime was connected to the financial instability as per basic economics, but that connection is getting weaker now. The last 10-12 years of low rates have not resulted in a financial meltdown anywhere. The maximum employment conditions have also failed to stoke up inflation. They might have increased the wage inflation, but that wage inflation has not fed into generalised inflation. Competition has ensured that companies have absorbed that in their margins without doing the price increase.

Post FOMC, stock markets are up, Dollar Index is down, emerging market currencies are overjoyed. The US 10-year yield stays elevated at 1.67. Gold inches up and Brent oil remains steady around 67$/bbl. Now readers would do well to fathom the implication when the stimulus becomes the permanent state. If there is no downside of providing support, then why should it not be done all the time. This is the standard MMT insight. We would be cautious to not take very generalised lessons here. As we wrote yesterday the luxury of being a pole in a unipolar world is not available to every country. The others still need to worry about deficits and balancing the budgets (either through reduced spending or tax increases). There are no free lunches as they say!