English (India)

Powell sounds less dovish than expected

calendar 19/09/2020 - 17:45 UTC

On CRE (commercial real estate) borrowing programs, Powell said it’s facing some legal challenges for their leverage issues and thus the Congress support is required here to pass some kind of legislation or innovation so that CREs are allowed to take more debt despite covenants.

On further evolution of forwarding guidance, Powell said the current forward guidance is appropriate and powerful and thus this is durable that will support the economy significantly in the coming years; i.e. there will be no change of forward guidance in the coming months. The Fed’s forward guidance is to hold rates near zero until the labor market conditions reach levels that are consistent with the committee’s assessments of maximum employment, until inflation reaches 2%, and until it’s on track to go above 2% moderately for some time.

Further on Fed’s latest bold forward guidance, Powell explained the Fed is not targeting any specific number like 4% or 3.5% for the unemployment rate, but only aiming at maximum employment as per Fed’s own assessment in the evolving (changed) post-COVID economic situation. Maximum employment means low unemployment, high labor force participation, higher wages; i.e. overall tight labor market. Regarding inflation (core PCE) the Fed is primarily targeting an average 2% by allowing it overshoot (moderately higher) over a short period of time, but not permanently; there is no specific formula.

On any additional financial support, whether it will materialize or not, Powell said he is confident it will eventually happen; now the question is how much and when. Powell also pointed out that the last big fiscal stimulus (CARES Act 1.0) is the main reason for some economic recovery (consumer spending). But, as the PUA (Pandemic Unemployment Assistance) fades, the U.S. consumer spending may also fade in the coming days amid corona/economic uncertainty and job insecurity.

Powell explained without CARES Act 2.0, the economy may suffer significantly. Apart from soft consumer spending, those vulnerable 11M COVID unemployed people, mainly associated with the consumer-facing service industry, will face bankruptcy (insolvency) and that will be a structural problem for the whole economy/society.

On any further change in monetary policy framework with regard to income inequality, Powell said it’s a legacy issue and apart from maximum employment issues for the vulnerable section of the society, the Fed has no instrument to fix that; only Capitol Hill (Lawmakers) can fix it through proper policy/legislation. And without that vulnerable section of the society, the U.S. can’t achieve maximum output/productivity.

Finally, Powell was asked to explain the rationale behind inflation overshooting for Main Street as ordinary Americans are quite perplexed for Fed’s higher inflation target, while Wall Street may in a good mood as it will ensure lower interest for a longer time and asset appreciation.

Powell tried his best to look smart and said high inflation is a bad thing, but too low inflation is also not good for the monetary policy perspective. If inflation stays very low, the Fed rate will be also too low near the lower bund (zero), which is the case right now (COVID-19). Then in some real financial crisis, there is less or no room at all to cut the interest rates further to support the economy. This is the situation now in the EU or in Japan, where they can’t cut the main interest rate (repo rate) below 0%, although the reverse repo rate has been slashed to negative in order to discourage banks to park their excess fund with the central bank rather than lending to the real economy.

Thus the Fed wants inflation to be 2% on an average over a period of time so that the Fed can normalize in order to be prepared for the next financial crisis as interest rate cut is the main weapon. The Fed can’t cut its repo (main interest rate) below 0% or there is no requirement for any negative RR in the U.S. perspective. The Fed does not want high inflation, but moderately above 2% for some short period of time, not permanently in order to normalize its ultra-accommodative monetary policy to prepare itself for the next economic crisis, usually every 10-12 years boom-bust cycle.


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