Fed policy raised questions about its own reaction function: Jahangir Aziz

In what is seen as a tactical retreat, the US Federal Reserve on Thursday decided to keep interest rates unchanged.

The Fed wants to take a little more time to evaluate the impact of global market volatility on the US economy, said Fed Chair Janet Yellen.

So what does the Fed’s move mean for Asian markets, particularly India? Bloomberg TV India caught up with Jahangir Aziz, Asia Economic Research, JPMorgan, to get an insight.

If I am not mistaken, you would have expected that the Fed liftoff would happen this time around. Now that it has not come through, your comments? Also, the Fed seems to be indicating that we could see a move either in October or December but most analysts are pointing only to 2016 for a liftoff. Where do you stand on that?

Let me address the first question first. So, yes, we had expected a very dovish lift. We had expected that the Fed would lift rates and would have a very dovish guidance over the pace.

We thought this would be important for the emerging markets worldwide, including emerging markets in Asia and India. Because this would bring risk back on to the emerging markets given the uncertainty that was one of the reasons why money was sitting on the sideline for the past three-four months.

Because the guidance was going to be dovish, it meant that there would be time before the US rates really rose to a point where it started pinching global financial conditions. What we did get was a dovish hold.

So the uncertainty remains — about when the Fed will move — but more importantly the reasons as to why the Fed held back did not give us very much consolation about what is happening outside of the US.

The Fed did not hold back saying that the US economy is strong, but they just had Janet Yellen saying the labour market growth had been strong.

The concern was that outside of the US, particularly in China and in emerging markets, the growth is very fragile, which is not a very positive statement for global investors to put money back in emerging markets.

You were talking about the uncertainty of the global environment but at this point the biggest uncertainty seems to be the Fed itself. At the same time, China is going to be the biggest concern and that is what the Fed said. Do you think China has the capacity to continue growing at the same pace or are we in for a sustained period of volatility?

Let’s break this question into two parts. First, more than the uncertainty of whether the Federal Reserve is going to lift today, tomorrow or the last Sunday of this year, I think what the Fed policy has done is to raise questions about its own reaction function.

In the past, the Fed policy impact on the US dollar exchange, its strength or weakness, was only important to the extent that it affected its own domestic conditions. There was never really any explicit mention of dollar strength.

Today, we have a Fed Chairman talking about dollar strength and weakness as part of the objective of not raising the rate. So is this just an episodic reason the Fed used not to raise the rate, or is this change we are seeing in the Fed’s own reaction function?

Second, we understand that a three-month delay really does not matter. In time, if we look at the dots, they are very gradual dots. So if they are going to delay the first move, the question really arises — is there enough room or enough luxury that the Fed will have to move actually in that gradual pace that is at this point in time promising?

So I think it erases a lot of uncertainties about the Fed’s own reaction function, whether or not the Fed will have the luxury to go at that very slow pace. I think this is important.

China will slow down the economy. That is what it has been doing for the past three years.

We are just waking up to the fact that Chinese authorities really mean it this time.

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