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By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Between Transitions & Tantrums
(Fairly) Quiet markets have been correlated to FOMC deference; which is highly plausible. But why is this FOMC in particular so spectator worthy? Our guess is because the Fed is confronted with a balancing act of walking a tight-rope between transition and tantrums.
And if that’s good enough for a circus … Point being, solid US economic recovery flanked by inflation at a 13-year high demands some kind of acknowledgement, if not response, from the Fed. To be fair, the Fed has already conceded strong economic recovery.
The dilemma though is that the 2013 “taper tantrum” episode (from the mere mention of “taper” at Jackson Hole by Ben Bernanke at that time) also raises the stakes (and policy uncertainty) for the Fed.
In this regard, the Fed’s paradigm shift to “flexible average inflation targeting” builds in more discretion in managing the upswing in price pressures during the course of the recovery. But that merely delays the inevitable; and comes with unfamiliar triggers and outcomes.
What’s unavoidable is the fact that terms like “normalization” and “exit” will have to be revisited in some shape or form; and sooner rather than later.
The two question for this meet will be whether;
i) the “Dot Plot” brings forward rate tightening (from a hold through 2023), and;
ii) and if “talking about talking about” “taper materialises or the Fed bats it away.
And as we pointed out in our “Week Ahead” publication yesterday, the risk-rewards of driving UST yields lower is less compelling, given that policy inflection is not beyond the horizon. As such, our reaction to (10Y) UST bond yields edging back towards 1.5% from testing low-1.4% is defined by the lack of our surprise.
As is the firmer footing of the USD; insofar that nominal yields are more likely to catch up to inflation expectations, thereby lifting real yields.
EUR (low 1.21), AUD (0.77-level), JPY (USD/JPY lifted above 110) and SGD (USD/SGD above mid-1.32) all point to cognizance about upside USD risks; as FOMC is awaited.
But for all of the dilemma inflation presents for the Fed, it poses a greater risk elsewhere.
India’s Inflation Resurgence …
Especially as rising upstream cost-push from commodities and food conspiring with the logistical impediments from Covid resurgence risk amplifying inflation transmission.
What’s more, rising oil prices threaten add a dimension of “stickiness” to inflation. Arguably, the RBI need not hasten to respond to the rise in inflation given that these cost-push pressures are emanating in the conspicuous absence of demand-pull mechanisms.
But equally, this is not a free pass for the RBI either. For one, even volatile components such as energy and food cannot be dismissed as being irrelevant to inflation expectations.
In particular, as CPI has once again breached the top end of the RBI’s 4+/-2% inflation target. What’s more, with the policy rate at a record low 4.00%, real rates are negative, and set to get more so in coming months; in turn, accentuating macro-/rupee- stability risks.
Which is to say that the RBI cannot dismiss “transitory” cost-push as easily. And this spells attendant policy inconvenience of having to abide by inflation risks despite lingering weaknesses in economic recovery inflicted by “second wave” devastation.
Hence, inflation resurgence, while not a imminent threat to the RBI’s accommodative policy stance, is nonetheless likely to be rendered a persistent constraint on the RBI’s policy.
Credit: Mizuho Bank Ltd
