Opinion | Jerome Powell spoke like a dove, but appearances can be deceptive

U.S. President Donald Trump arrives shakes hands with Jerome Powell, his nominee to become chairman of the U.S. Federal Reserve at the White House in Washington, U.S., November 2, 2017. REUTERS/Carlos Barria - HP1EDB21HQF0Y

Ravi Krishnan

The general impression about Jerome Powell’s first speech at the Jackson Hole jamboree of central bankers was that the US Federal Reserve chairman sounded dovish as he defended his gradualist approach to raising interest rates. Stocks jumped on Friday, bond yields fell, and the US dollar weakened against a basket of currencies of its trading partners.

In the rest of Asia, and India too, markets strengthened on Monday. However, appearances can be deceptive. The choices confronting US monetary policymakers are difficult and present a big danger to emerging markets like India.

The US Fed has increased its policy rate twice this year and is poised to raise it two times more. But what after that?  The path is no longer clear for future rate hikes.

Powell’s speech seems to suggest that growth might taper and inflation, too, will be muted. The Fed has an inflation target of 2 percent and currently there is no visibility on whether inflation will overshoot.

Remember, the Fed is also under pressure from US President Donald Trump, who has signalled his displeasure at the central bank hiking rates even as a fiscal stimulus is on. The rate hikes by the Fed have also strengthened the US dollar, making American exports non-competitive at a time when Trump is fighting a trade war.

Third, as some analysts point out, the Fed could also factor in global developments. A trade war with China, which could derail global growth, slower growth in China, and turbulence in emerging markets from lower global growth spilling over into US financial markets, might force the Fed policymakers to defer raising interest rates.

While the US Fed is not particularly known to factor in other markets, there is precedence when Alan Greenspan cut rates in 1998 despite low unemployment and high inflation. Indeed, Powell did say that “there are risk factors abroad and at home that, in time, could demand a different policy response.”

That said, it is too early to decisively say that the Fed will go slow. Remember that the US economy is growing at a scorching 4 percent-plus pace and unemployment is at a 20-year low. High oil prices, partly driven by US sanctions on Iran, are a threat to inflation.

At this pace of growth, there is every chance that capacity utilisation could get maxed out and push inflation further. Moreover, US consumers expect one-year ahead inflation to be at 3 percent expectations of households, a June survey by the Federal Reserve of New York showed. Core inflation, too, is projected to hit 2 percent soon, the highest since 2012.

Moreover, the minutes of the last Fed open market committee meeting suggested that it was considering a change in policy stance from accommodative to neutral. While Powell has warned about the “two errors that the committee is always seeking to avoid” — that of moving too fast and shortening the expansion versus moving too slowly and risking a destabilising overheating — it remains to be seen how much the Fed is willing to risk inflation going higher.

The US tightening presents a key risk to emerging markets, including India. Yes, local macroeconomic indicators and earnings per share growth are improving for Indian stocks.

Ultimately, it is a play on global liquidity, especially when valuations are so high. While portfolio flows have improved in August, it won’t take much for them to reverse course. The new highs that markets touched in recent times could well be temporary.