Fed unlikely to tighten the screws anytime soon

Finance | Andrew Wong 21 Jun 2021

The outcome of the US Federal Reserve Board's policy meeting last week raised concerns among investors that higher interest rates and the tapering of asset purchases could happen sooner than we think.

Fed policymakers have brought forward the expected timeline for raising interest rates from 2024 to 2023, but as 2023 is still at least 19 months away, is it too early to start worrying about belt-tightening?

Well, the Fed may still need to solve several problems, the first of which is the current concern over rising inflation.

But while the Fed increased its personal consumption expenditure inflation estimate to 3.4 percent for 2021 - which shows that it is aware of inflation - it only slightly hiked the PCE estimate from 2 percent to 2.1 percent for next year and 2023, which also reflects its view that the current rise in inflation is a short-term problem and that longer-term inflation pressures will be muted.

If you look at the market-exit mechanism that the Fed turned to after its third round of quantitative easing in 2012, following the 2008 global financial crisis, the Fed said that if expected inflation was higher than 2.5 percent and unemployment was below 6.5 percent, it would start to gradually reduce bond purchases.

As a result, the Fed did not begin to scale back its bond purchases until January 2014, and did not begin to raise interest rates until the middle of 2015.

That is to say, after the Fed started its first round of QE in March 2009, it began to withdraw QE almost five years later.

As a result, the US economy and financial markets suffered from lack of momentum and this led to another rate cut by the Fed in August 2019. This will be on the Fed's mind right now.

After the financial tsunami, the US economy did not see light at the end of the tunnel until five years later.

Covid-19 has hurt the global economy as badly as the financial tsunami.

The only difference is that governments and central banks around the world have injected funds into the market more rapidly and on a larger scale this time round.

But does this mean that the global economy and the United States will recover much faster than they did after 2008? If the Fed leaves the market too early or raises rates too soon, the impact on the economy will be hard to gauge if the ideal economic data are short-lived.

With the pandemic continuing threaten nations, the global economy has not been able to enter a consistent recovery phase.

In 2012, the Fed set its inflation target at 2.5 percent and it did not turn off the money taps until inflation hit that level.

However, while inflation this year could be higher than 2.5 percent, the Fed expects inflation in 2022 and 2023 to run at only at 2.1 percent, a level which is still acceptable to the central bank.

Meanwhile, China's moves to tame prices will also help ease global inflationary pressures.

Therefore, it's a bit of an overreaction to assume that the Fed will reduce its bond purchases or raise interest rates in the next 12 months in the face of short-term inflationary pressures.

Financial markets in the United States were very volatile last week, but even after the huge sell-off, the S&P500 index is still up by 10 percent this year.

And, coupled with last year's gains - given the fact that US economy is still not back to where it was before the pandemic and the S&P500 is indeed a bit too high - investors should not be surprised that there was profit-taking last Friday, the "fourth settlement day," and profits were locked-in at the half-year mark.

Andrew Wong is chairman and CEO of Anli Securities

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