The Jackson Hole Economic Policy Symposium, held annually since 1978, is a conference for central bankers to exchange views on monetary policy and the economy and is closely watched as it usually signals the direction of central bank policies. The focus of this year’s symposium is when the Fed will scale back its accommodative policy. This not only involves the direction of the U.S. monetary policy but also plays a guiding role for global central banks and will have an important impact on the global economic recovery.
At this year’s symposium, Federal Reserve Chairman Jerome Powell gave his views on the direction of the Fed’s monetary policy. He said the U.S. economy continues to make progress towards the Fed’s benchmarks for reducing its pandemic-era emergency programs. He underpinned his views on monetary easing by emphasizing that the current bout of inflation is temporary. He did not specify when the Fed planned to reduce asset purchases, saying it could be this year. He also signalled caution about any eventual decision to raise interest rates. That was taken to mean the Fed could take longer to begin the process of raising interest rates after tapering, which brings a relatively optimistic outlook to the market.
Judging from the market reaction, Powell’s speech and stance perceived to be “dovish” are in line with market expectations. In his market-friendly tone, Powell’s cautious remarks on tapering are intended to prepare markets for a taper and avoid a “taper tantrum”. So far, Powell’s approach is working. For now, most investors are comfortable with his view of “temporary inflation”, and a growing consensus on a less accommodative approach is emerging in the market. From what the Fed has previously revealed, the market generally expects the Fed to begin tapering its easing policy at the end of this year or early next year and to start raising interest rates in 2023. This policy shift is gradually emerging.
Of course, there are still uncertainties about the course of this policy shift. According to researchers at ANBOUND, changes in inflation and the pandemic could influence the direction of the Fed’s monetary policy. Since the beginning of this year, as the U.S. economy has been recovering from the COVID-19 pandemic at a faster pace, the recovery of the U.S. economy has been divided despite the record monetary and fiscal stimulus. On the one hand, the inflation level has been breaking the record with the Fed’s “massive easing”. The employment level, on the other hand, has risen slowly. This puts the Fed in a dilemma. Through quantitative easing, the Fed hopes to boost the economic recovery and further restore the employment level to the pre-pandemic level. The Fed, however, is worried that short-term demand and excess money supply will lead to rising inflation, which will hurt economic growth and employment. Since this year, the market has been worried that if inflation gets out of control, the Fed will speed up the pace of tapering, bringing disastrous consequences to capital markets and the U.S. economy.
Another wild card is the new outbreak brought about by the Delta variant. If the pandemic worsens and raises a new round of risks, it will exacerbate the uneven economic recovery. The Fed has virtually nothing more to do about it. It can neither tighten nor loosen and can only rely on U.S. fiscal stimulus to boost the economic recovery. For now, with widespread vaccination, the impact of the pandemic on the economy is not significant, and the likelihood of the Fed tapering as scheduled is high.
However, unlike the policy shift that led to the “taper tantrum” when Janet Yellen was in charge of the Fed, the Fed’s exit strategy for monetary policy is expected to be much smoother this time around. On the one hand, the market has fully understood and prepared for this. On the other hand, the Fed has also set the stage for subsequent tapering and normalization of monetary policy by establishing some repo facilities. The high level of Fed reverse repos has actually set the stage for a tightening of dollar liquidity. Globally, some emerging market countries, including Brazil, Chile, Mexico, Turkey, and Russia, have started to withdraw from easing and even raised interest rates in response to inflation and the Fed’s policy shift. South Korea, a representative of the developed countries, has also started raising interest rates, and the European Central Bank is likely to follow the Fed’s lead. In this way, global monetary policy will gradually exit from the unconventional policies under the pandemic. Although the process may be a long one, the overall trend is expected to remain unchanged. Still, it may not be easy for countries to achieve U.S.-like economic growth, and the uneven global recovery will be exacerbated by inflation.
For the capital markets, although the Fed’s tapering will affect liquidity across the market, its impact is still uneven. During the phase of expected interest rate hikes, the stock market fluctuated and showed some weakness. The trend of the U.S. stock market was still positive in the process of the Fed’s policy normalization. As the dollar liquidity tightens and interest rates rise, emerging markets become more volatile and tend to fall, driven by capital outflows and currency depreciation. The gradual withdrawal of unconventional policies by the Fed will cause interference in China’s RMB exchange rate and capital flows, but in the case of capital controls, the impact of such interference is not significant. Meanwhile, China’s capital markets are relatively independent of the rest of the world and have limited exposure to fluctuations in the U.S. dollar.
As the pandemic and policy normalization process in China is not synchronized with that in the U.S., the Chinese policies are more independent than those of the U.S. From a policy perspective, the normalization of monetary policy by the Fed and central banks around the world implies that the People’s Bank of China (PBoC) has very limited room for further easing and will face greater pressure to maintain its current neutral stance.
Final analysis conclusion:
Federal Reserve Chairman Jerome Powell’s speech at the Jackson Hole Economic Policy Symposium came as no surprise. His seemingly “friendly” and “accommodative” stance makes the Fed’s path towards normalization of monetary policy clearer. This will begin to drive a shift in monetary policy by central banks around the world, with implications for the global economy and capital markets.
Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.Wei Hongxu, graduated from the School of Mathematics of Peking University with a PhD in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing.
