Reducing inflation to require sustained period of below-trend growth

US Federal Reserve chair Jerome Powell on Friday at the Jackson Hole Economic Symposium hinted that the Central Bank is likely to continue increasing interest rates and keeping them elevated to combat inflation. Powell tried to dispel any hopes for a less-aggressive monetary policy stance. Reducing inflation is likely to require a sustained period of below-trend growth.

Market participants had their ears trained to catch any hint of change of monetary-policy stance and to get a sense of the trajectory of inflation. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, it will also bring some pain to households and businesses. He relied on the historical record that cautions strongly against prematurely loosening policy.

Despite the ease in price pressures reflected in PCE for July, the US Fed will wait till it is confident that inflation is moving down sustainably. Fed’s decision at the September 20-21 meeting will depend on the totality of the incoming data and the evolving outlook.

Expectations ahead of the speech were mixed with some investors hoping for a dovish outlook, while some analysts expected a hawkish tone. Speech at Jackson Hole symposium historically gives an indication of direction of rate hikes/cuts over the next few quarters. Fed chair’s speeches at Jackson Hole events are more profound than the usual policy speech, so there’s much more to chew on.

Equities were the last asset class to accept the notion that the Federal Reserve likely won’t be pivoting to a less aggressive monetary policy stance soon. Judging solely by movements in yields and exchange rates, it seems like bonds, gold and the dollar all days ago started pricing in the idea that the Fed funds rate would remain higher for longer. Stocks, on the other hand, experienced a few hiccups over the past week except on Friday post the speech.

According to the CME FedWatch tool, the futures market was pricing in a 61% chance of a three-quarter point rate hike after Powell spoke on Friday, down from 64% the day before. The real fear appears not to be about the size of the next hike, but when the hikes stop and how long rates will stay high—even if it means causing a recession.

We are just about to enter the stock market’s worst month—September. The S&P 500 index has averaged a 1% loss in September dating back to 1928, says Dow Jones Market Data. The sell-off may have already begun.

Indian markets could get impacted by the turn in global sentiments and as more investors turn risk averse ahead of the historically down month of September. However the intensity and amount of fall in India will be limited as its economy may not be linked fully with the happenings in the US economy. FPIs as a group may get swayed initially by the bearish outcome but later come back into India markets given its relative resilience and higher growth expectations.

(The author is Head of Retail Research at Securities.
Recommendations, suggestions, views and opinions are his own. These do not represent the views of Economic Times)