Cash flow. Taper, yes; tantrums, no

The equanimity with which financial markets have accepted US Federal Reserve Chairman Jerome Powell’s speech at the annual economic policy symposium in Jackson Hole is largely because of the promise he held out that the taper of easy monetary policy will be very gradual so that global liquidity will not be impacted in the near term. Most equity markets traded with gains and the dollar and sovereign bond yields moved lower following the speech. Powell added three points that would have served as a salve to financial markets. One, he said that the committee will continue to assess all incoming data closely to study the impact of the delta variant on the economy, implying that tightening will be contingent upon sustained economic recovery. Two, he said that even after monthly asset purchases end, the Fed will not be in a hurry to reduce the elevated holdings of longer-term securities. This is significant as it implies that the liquidity infused so far will not be withdrawn in a hurry. Three, he stressed that reduction of monthly bond purchases is not linked with policy rate hikes in any way and employment conditions need to show more improvement before the rate hike cycle begins.

The Fed has been careful to not repeat the mistake made in 2013, when the news of the impending taper was communicated in an abrupt manner, causing the taper tantrum of 2013. This time, markets have been given sufficient notice through speeches and media interactions of various Fed officials. Also, with the Fed’s balance sheet expanding over $3.8 trillion since last March and the government debt-to-GDP reaching record levels it was inevitable that the Fed would begin monetary tightening soon. Powell’s assurance on rates remaining low for now would have been especially heartening to financial markets since the ultra low interest rates in the US play a large role in driving global asset prices higher. Powell’s concern regarding labour market, where total employment is still 6 million below the February 2020 levels, implies that the rate hikes may not begin any time soon.

The Reserve Bank of India (RBI) is also facing a problem of too much liquidity in the system due to the easy monetary policy induced by the pandemic and the central bank is also beginning to take baby steps towards policy normalisation. Governor Shaktikanta Das, in a recent interview with this newspaper, acknowledged that RBI has begun normalising liquidity operations through the VRRR auctions which will gradually increase to ₹4 lakh crore by the end of September. But he stressed too that the RBI is not draining out liquidity yet. The liquidity infused so far remains in the system and reduction of liquidity going ahead will be contingent upon the evolving macroeconomic situation. Given that all central banks are going to great lengths to not derail the nebulous recovery, financial markets seem to have nothing to fear, as of now.

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