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Khatija Haque - Head of Research & Chief Economist
Published Date: 23 August 2021
In recent weeks, members of the US Federal Reserve’s rate setting committee and regional Fed presidents have used interviews and speaking events to telegraph to the market that monetary stimulus may start to be withdrawn sooner rather than later. Since June last year, the Fed has been buying at least USD 80bn of Treasuries and USD 40bn of mortgage-backed securities every month, and it pledged to do so until “substantial further progress” had been made towards achieving the twin goals of low unemployment and average inflation at 2%.
As Covid-19 vaccines were rolled out and restrictions on activity were eased, US economic growth accelerated to 6.5% in the second quarter of this year and inflation surged to the highest level in more than a decade, raising questions about whether the Fed was behind the curve in continuing to pump significant liquidity into the financial system. However, job growth was weaker than expected in April and May, and policy makers were confident that the surge in inflation was due to re-opening friction and supply chain disruptions that would prove transitory. Nevertheless most Federal Open Market Committee (FOMC) members agreed in July that “substantial further progress” had been achieved in meeting the Fed’s inflation goal albeit not on the employment front.
The better-than-expected jobs data in July would have provided greater confidence about the labour market however, with 943 000 new jobs added and the unemployment rate falling to 5.4% from a pandemic-peak of 14.8% last April. If the economy continues to improve, and the pace of job growth is maintained, then the Fed could start to taper asset purchases before the end of this year rather than in early 2022. This has been the message communicated by several Fed presidents and FOMC members over the last few weeks.
However, recent data in the US and other major economies suggests that economic growth has already peaked, and the spread of the Delta variant of the coronavirus may weigh on growth in the coming months. US consumers bought fewer goods in July than they did in June, and consumer sentiment in August fell to the lowest level since the start of the pandemic last year. In some US states, hospital admissions due to Covid-19 have now exceeded the previous peak. While this has not yet led to tighter restrictions being imposed by the federal government, some airlines are reporting weaker demand for domestic travel, and some businesses are delaying the return to offices.
The Delta variant poses a risk to economic activity outside the United States as well. Last week the Reserve Bank of New Zealand kept its benchmark interest rate on hold instead of hiking as expected, after the country went into lockdown following the first community transmission of Covid-19 in six months. Restrictions have been extended in Australia, Japan and other southeast Asian countries as case numbers have surged. In China, a relatively small number of Delta variant cases precipitated lockdowns in several provinces and resulted in a terminal at the world’s third busiest port being shutdown in early August. Retail sales, exports and imports all slowed in China in July.
Global growth concerns and the potential impact of the Delta variant on economic activity have affected financial markets too. The 10-year US Treasury yield is down almost half a percentage point since the end of March, even as the Federal Reserve looks likely to taper its asset purchases sooner rather than later. Commodity prices – including oil prices - have declined as demand expectations are revised lower and, in the case of oil, supply is set to increase.
All eyes are now on the Jackson Hole Economic Symposium, which will take place over 26-28 August, and where Fed Chairman Jerome Powell is scheduled to speak. He may offer further clues about how the FOMC is thinking about monetary policy and the risks to the economic outlook at this juncture. However, the earliest that the FOMC can actually announce a change in its asset purchases is at its next meeting on 21-22 September.