Sustained inflation has proven to be more than transitory and it has started to raise concerns over policymakers globally, unfolding a hawkish wave of central banks shifting stance. The Federal Reserve hinted at imminent tapering expected to be announced in their upcoming meeting in November while the market prepares expectations towards rate hikes in 2022 and 2023. The hawkish shift in stance induced a significant rise in U.S. treasury yields from 1.30% to 1.56% in a matter of days while Jerome Powell, Chairman of the Fed said at his congressional hearing that inflation is now more concerning than earlier this year. However, Powell highlighted that even with tapering the Fed will continue to buy bonds until mid-2022 and that employment is still a long way to go before considering any further adjustment in policy approach. The Fed still believes that inflation will come down in the mid-term, especially as supply chain bottlenecks ease, pointing at supply-chain restrictions at the heart of it.
However, unemployment keeps making small progress towards recovery as disappointing job reports in August suggested that summer growth drivers were offset by the impact of the delta variant on the economy. Non-farm payrolls figures failed to impress with 235k new jobs created in August, while market participants set expectations at 750k. Despite the disappointing figures, unemployment fell 0.2% in August posting 5.2% as previous figures for June and July were revised up to improve the aggregate figures, although it is still a long way from the Fed’s target of full employment. Upcoming job reports in October will be closely watched by policymakers as efforts from U.S. authorities to improve vaccine distribution hold hopes that might have a positive impact over economic drivers. The FDA announced the full approval of the Pfizer vaccine which enabled authorities to activate new channels of distribution.
Moreover, the U.S. congress faces budgeting constraints amid the end of the fiscal year in the U.S. and Joe Biden ambitious USD 3.5 trillion spending plans. Hours before the fiscal deadline on the 30th of September, the U.S. senate leader Schumer announced a last-minute stopgap bill to keep the government funded until 3 December, 2021. The last minute bill saved the Biden administration from the embarrassment of a government shutdown in the middle of the pandemic, although democrats are not out of the woods just yet. Treasury Secretary, Jannet Yellen flagged during her congressional hearing alongside Powell, that the U.S. will reach the debt ceiling by 18th October, resulting in default and financial crisis if lawmakers fail to suspend or increase the debt limit by then.
Aside from internal drivers, we witnessed across the month a dampened sentiment after China’s authorities and top executives announced that Evergrande, the second-largest real estate developer in the world, was missing upcoming interest payments for its outstanding debt valued around USD 288 billion. Beijing seems reluctant to bail out the real estate giant, although it is taking steps to limit the damage in the financial system. The announcement shook equity markets globally amid fears of contagion through the financial global system. The broader risk off sentiment underpinned the dollar triggering a significant demand for the safe-haven greenback. The U.S. dollar index, which tracks the performance of the greenback against a basket of six major currencies, rallied 1.69% after Evergrande announced its credit fallout inducing a wave of risk off flows. In addition to the risk averse dollar demand, Fed officials' announcement of imminent tapering ignited the spike in Yields creating a snowball effect making the dollar close the month with solid momentum.
The Federal Reserve faces resolving “tension” between high inflation and still-elevated unemployment, which means that the central bank’s two goals are in potential conflict. Chairman Powell acknowledged that this is not a situation that policymakers have faced for a very long time and it's one in which there is tension between the objectives of the Fed’s mandate. Inflation is high and well above the target levels and yet there appears to be slack in the labor market. The comments for the Chairman raise eyebrows over market participants bringing fears of “stagflation” lived back in the 70’s that combined high unemployment and fast rising prices. Policymakers' working hypothesis is that inflation will ease on its own as the global economy returns to normal after a rocky reopening from the coronavirus pandemic and as supply chain bottlenecks ease policymakers will have room to shift policy more comfortably.
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