Dear Reader,
US Federal Reserve chair Jay Powell’s Jackson Hole speech was the most-awaited market event of the week. It did not disappoint. Markets were keen to know his stance on whether he would show more concern on inflation or on unemployment and what that meant for interest rates. Powell has had one eye on the risks posed by President Donald Trump’s reciprocal tariffs to prices, but a softening job market has also been a source of concern.
Powell’s overall assessment of the economy is that it is resilient, despite “sweeping changes in economic policy”— a reference to the havoc caused by tariffs and immigration policy. The labour market remains near maximum employment and inflation is somewhat elevated, but is down from its pandemic highs. But, crucially, he also said that “…the balance of risks appears to be shifting”.
He pointed to the difficulty in assessing if the changes taking place were cyclical and therefore, temporary, or structural and need to be addressed. While the weak jobs report did surprise, other indicators of labour market conditions have remained stable. Still, although labour market is balanced, it’s because both demand and supply have declined, which is ‘an unusual situation’. It’s a risky situation that can blow up quickly.
The slowdown in GDP in the first half is not just due to slowing consumer spending, but also due to slower output. The big question mark: inflation. Tariffs are working their way through the supply chain, leading to higher prices. August will see the impact of the reciprocal tariffs being felt. While inflation is on the rise, the Fed expects this to accumulate over the coming months as revised tariffs take hold. While it raises the risk of an “ongoing inflation problem”, Powell’s base case scenario is that the effects will be “relatively short lived”. That will be music to Trump’s ears, as he has been pooh-poohing any risk to inflation from his tariffs.
But Powell also cautioned that one-time does not mean the bump will be visible at once, but will gradually build up. There is, of course, the risk that inflation becomes a bigger problem in the process, but that needs to be managed. He offers the example of workers negotiating a higher wage to deal with inflation. But he believes that outcome as unlikely. After all, if the labour market is soft, then labour’s ability to negotiate higher wages will be weak.
To conclude then, the near term risks to inflation are to the upside but risks to employment are to the downside. While the Fed still has the leeway to proceed carefully given the situation, Powell said, “Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance”.
The Fed could go wrong in its assessment of the job or the inflation situation, but it has chosen the former problem to address, to provide support to employment. If this shift leads to a cut in the September meeting, it will lead to lower interest rates for consumers and for businesses. The effect of higher tariffs on household budgets and corporate profit and loss statements can be blunted by cheaper money to some extent. Of course, asset markets too will get lifted, bringing the rising wealth effect into play which can also boost demand. US 10-year bond yields were down by 33 bps, the S&P 500 was up by 1.6 percent and the Nasdaq was up by 2 percent at 9 pm.
What about domestic markets? We had written this week about how tariffs have negaitvely impacted confidence in India’s market and also wrote about whether Powell will take a hawkish turn or not is the main risk confronting markets. The overhang of whether US rates will go on a declining path has been removed, for now. Traders have pushed the probability of a rate cut in September up to 90% from 75% on Thursday and the chances of a 75 bps cut by year-end moved up from 25% to 37%, according to a WSJ report based on CME Group data.
If lower US interest rates result in money flowing out of the US in search of higher yielding assets, then Indian bond and equity markets could benefit from a slice of those flows. But tariffs are likely to act as a negative counterweight. Even an S&P sovereign rating upgrade did not lead to celebration in India’s bond market. August 27th is when the additional 25% duty on US imports from India goes into effect. The Russia-Ukraine peace deal is not showing signs of making visible progress in terms of trilateral talks.
The main positive for India’s markets was the government’s push to boost the domestic economy by lowering GST rates. We wrote about this topic extensively. We asked if the GST overhaul can counter the tariff pain for Indian equities, whether GST cuts can speed up urban demand revival, whether a fiscal push can trump global factors, sustain the stock market recovery and, finally, brought to you a market view: GST reforms to impact September quarter, analysts bet on H2 for earnings growth.
The government is moving quickly on the GST rationalisation process. The Group Of Ministers has cleared the proposal which will now be placed before the GST Council. State finance ministers will be keen to know the revenue loss they are facing — which is why it will be a stimulus — and how they will be compensated. An easy answer is that an increase in consumption should make up for that, but the difficult part is in estimating if it will indeed increase, by how much and will it be enough?
This calls for smart manoeuvring by the government, so that they are able to implement these changes quickly in time for festival season demand. The promise of a discount can be enough to get Indian consumers to postpone purchases by a few months, be they big or small ticket goods. But that would deal a blow to company sales and earnings in a crucial period for sales. While Powell appears to have looked through Trump’s tariffs for now, for India they remain a danger. The big question for us is whether the Centre’s fiscal push will be enough to address external uncertainties.
Cheers,
Ravi Ananthanarayanan
(Your regular Moneycontrol Pro Weekender columnist Manas Chakravarty will be back next week)
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