US Federal Reserve Chairman Jerome Powell made it clear at the Jackson Hole Economic Symposium that it is quite clear that the US central bank will continue to tighten monetary policy for as long as it takes to bring inflation towards the long-term target of 2 percent. . This rhetoric is likely to mitigate the excessive optimism seen in stock markets about Fed weakness, driven by moderating inflation over the past few months in the US and other countries. The statement also indicates that the rupee is likely to remain under pressure for the foreseeable future. The Fed chief is right to wait for more data points before revising his stance on inflation, given that the core personal consumption expenditures index – which the Fed uses to measure inflation – remains at a three-decade high of 4.6 per cent. With geopolitical tensions showing no sign of abating and tightening labor market conditions in the US driving up demand, inflation could continue to be a concern this year. Most important is Powell’s statement that fighting inflation takes precedence over growth and is likely to be a period of sustained “below trend” growth as this fight against inflation continues.
The US central bank’s efforts to curb demand have already slowed growth with real GDP for the June 2022 quarter falling 0.6 percent, after a 1.6 percent drop in the March 2022 quarter. The warning that households and businesses need to prepare for some pain ahead suggests that That growth is likely to take a hit during the rest of 2022 as well. It is also possible that the Fed will continue to charge policy rate increases to slow growth and lower demand. After increasing the fed funds rate by 75 basis points per meeting in the last two policy meetings (June 16 and July 27), a similar rally appears imminent at the September meeting, as the policy rate moves toward the expected 4 percent target (now at 2.25-2.5 percent). , versus 0.25-0.5 per cent in March of this year) by the end of 2023. Stock markets, which have been gathering strength in hopes of a slower pace of rate hikes, will now have to reset their expectations. While the US benchmark S&P 500 is up 10 percent since its June lows, India’s Nifty50 index is up 15 percent in the period. The comfort point is that India finds itself in a much better position with regard to inflation, with the CPI falling sharply from a peak of 7.79 percent in April to 6.8 percent in July. Since inflation in India is largely driven by supply, the Reserve Bank of India (RBI) does not have to take drastic steps to restrain growth, like the Federal Reserve.
However, the Reserve Bank of India will have to adjust the policy rates in order to maintain a sufficient spread between the Indian and US sovereign bond yields. With the dollar index strengthening again, the rupee is likely to come under renewed pressure, as foreign portfolio investors reallocate debt investments to US Treasuries. With foreign exchange reserves down 11 percent from their 2021 peak, it is clear that direct intervention in currency markets will not be possible for long. Especially in light of the sharp decline in the import cover in recent months. The Reserve Bank of India will need to look at other tools to boost foreign flows, including expediting the inclusion of Indian government securities in global bond indices.
August 28, 2022