USDJPY slips on more dovish Fed hold but recovered on higher US bond yield

calendar 01/05/2021 - 18:00 UTC

USDJPY closed around 109.29 Friday, surged almost +1.27% on higher US bond yields and the market perception of Fed’s QE tapering start by Dec’21. Although Fed Chair Powell is trying his best (talk down art/jawboning) to convince the market that Fed is still not ‘thinking about thinking’ normalization (gradual QE tapering and rate hikes) despite visible progress of COVID herd immunity (vaccinations) and U.S. economic recovery, the market is not buying Powell’s punch bowl and believes that Powell may indicate about QE tapering in his Aug Jackson Hole speech. Also, despite claiming Fed is not even thinking about any QE tapering in 2021, Powell as well as other FOMC/Fed officials are now actively talking about QE tapering.

On Wednesday (28th April), USDJPY slips from 109.08 to 108.50 after more dovish hold by Fed. On Wednesday, all focus was on Fed’s Chair Powell, whether the FOMC policymakers are ‘thinking about thinking about’ QE tapering. When asked about it, Powell flatly rejected the QE tapering thinking at this moment. On Wednesday, Powell painted a rosy picture of the U.S. economy, but showed no sign that the Fed would change the course of monetary policy anytime soon due to the ‘uneven and far from complete’ recovery: "It will take some time before we see substantial further progress”.

Powell refrained from any QE tapering hints and reiterated unless there is ‘substantial further progress’ of the Fed’s dual mandate (maximum employment and price stability), Fed will be on hold. Powell again downplayed any uptick in inflation as ‘transitory’ mainly on lower base effect (y/y basis). But Powell also pointed out any consistent spike in inflation (core PCE) above Fed’s expectations, the U.S. Central Bank will use appropriate policy tools to address that.

On Wednesday, as unanimously expected, Fed kept its all policy rates and QE buying unchanged:

Transcript of Chair Powell’s Press Conference Opening Statement: April 28, 2021

Good afternoon. At the Federal Reserve, we are strongly committed to achieving the monetary policy goals that Congress has given us: maximum employment and price stability.

Today my colleagues on the FOMC and I kept interest rates near zero and maintained our sizable asset purchases. These measures, along with our strong guidance on interest rates and our balance sheet, will ensure that monetary policy will continue to deliver powerful support to the economy until the recovery is complete.

Widespread vaccinations, along with unprecedented fiscal policy actions, are also providing strong support to the recovery. Since the beginning of the year, indicators of economic activity and employment have strengthened. Household spending on goods has risen robustly. The housing sector has more than fully recovered from the downturn, while business investment and manufacturing production have also increased. Spending on services has also picked up, including at restaurants and bars. More generally, the sectors of the economy most adversely affected by the pandemic remain weak but have shown improvement. While the recovery has progressed more quickly than generally expected, it remains uneven and far from complete.

The path of the economy continues to depend significantly on the course of the virus and the measures are undertaken to control its spread. Since March, progress on vaccinations has limited the number of new cases, hospitalizations, and deaths. While the level of new cases remains concerning, especially as it reflects the spread of more infectious strains of the virus, continued vaccinations should allow for a return to more normal economic conditions later this year. In the meantime, continued observance of public health and safety guidelines will help us reach that goal as soon as possible.

As with overall economic activity, conditions in the labor market have continued to improve. Employment rose 916,000 in March, as the leisure and hospitality sector posted a notable gain for the second consecutive month. Nonetheless, employment in this sector is still more than 3 million below its level at the onset of the pandemic. For the economy as a whole, payroll employment is 8.4 million below its pre-pandemic level. The unemployment rate seems to remain elevated at 6 percent in March, and this figure understates the shortfall in employment, particularly as participation in the labor market remains notably below pre-pandemic levels.

The economic downturn has not fallen equally on all Americans and those least able to shoulder the burden have been the hardest hit. In particular, the high level of joblessness has been especially severe for lower-wage workers in the service sector and African Americans and Hispanics. The economic dislocation has upended many lives and created great uncertainty about the future.

Readings on inflation have increased and are likely to rise somewhat further before moderating. In the near term, 12-month measures of PCE inflation are expected to move above 2 percent as the very low readings from early in the pandemic fall out of the calculation and past increases in oil prices pass through to consumer energy prices. Beyond these effects, we are also likely to see upward pressure on prices from the rebound in spending as the economy continues to reopen, particularly if supply bottlenecks limit how quickly production can respond in the near term. However, these one-time increases in prices are likely to have only transitory effects on inflation.

The Fed’s response to this crisis has been guided by our mandate to promote maximum employment and stable prices for the American people, along with our responsibilities to promote the stability of the financial system. As we say in our Statement on Longer-Run Goals and Monetary Policy Strategy, we view maximum employment as a broad-based and inclusive goal. Our ability to achieve maximum employment in the years ahead depends importantly on having longer-term inflation expectations well anchored at 2 percent.

As the Committee reiterated in today’s policy statement, with inflation running persistently below 2 percent, we will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. We expect to maintain an accommodative stance of monetary policy until these employment and inflation outcomes are achieved.

With regard to interest rates, we continue to expect it will be appropriate to maintain the current 0 to ¼ percent target range for the federal funds rate until labor market conditions have reached levels consistent with the Committee’s assessment of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. I would note that a transitory rise in inflation above 2 percent this year would not meet this standard.

In addition, we will continue to increase our holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum employment and price stability goals. The increase in our balance sheet since March 2020 has materially eased financial conditions and is providing substantial support to the economy. The economy is a long way from our goals, and it is likely to take some time for substantial further progress to be achieved.

Our guidance for interest rates and asset purchases ties the path of the federal funds rate and the size of the balance sheet to our employment and inflation goals. This outcome-based guidance will ensure that the stance of monetary policy remains highly accommodative as the recovery progresses.

To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Fed will do everything we can to support the economy for as long as it takes to complete the recovery.

Thank you. I look forward to your question

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In Q&A session:

To start talking about QE tapering: Powell said the FOMC still not discussing QE tapering as it’s not the time yet. Although there is some progress of the Fed’s dual mandate goals, it will take some time before any substantial further progress.

Whether Fed will go for normalization, even if the U.S. does not reach herd immunity: Powell explained Fed’s primary goal is substantial further progress for its dual mandate to go for the QE tapering. Although herd immunity against COVID is a subject of health experts, without the same, public scarring factor will continue to affect the recovery of the economy. Public confidence will not come back without visible herd immunity and it will continue to affect labor market recovery, especially consumer-facing service industry. Powell also pointed out that to achieve substantial further progress of the Fed’s dual mandate, there is also a need for substantial further progress of COVID curve flattening through mass-vaccinations and other processes (natural infections). Powell also warned that there may be some regional outbreaks and some resurgence of COVID next fall.

Powell was asked about possible Fed action if inflation unexpectedly spikes over +2% for a longer period without substantial progress of employment/real economy. Powell said it’s very unlikely for such divergence (inflation consistently above 2% without near maximum employment goals). But even if such divergence happens, Fed will assess the inflation aspect-how high it’s above the target and how long it will take to revert to the target.

On long-term pubic COVID scarring despite monetary and fiscal stimulus in place, Powell said it’s a reality. And post-COVID, there may be some structural change in the economy like tech, AI upgrade, which may affect jobs of some consumer-facing service industry. So Fed has to take care of all such issues for its maximum employment mandate.

On any localized housing market bubbles, Powell said the Fed is watching the housing market carefully, but there is no bubble as most of the housing buyers/borrowers have prime credit ratings, not 2008 like sub-prime. Powell pointed out the current state of the hot housing market as demand & supply mismatch amid COVID disruption and hoped that the price distortion will be corrected soon, paving the way for more jobs in that industry.

Powell was asked about current labor market issues like lack of sufficient workers in some sectors for some issues like scarring, childcare, etc. Powell said apart from scarring, and childcare issues, lack of proper skill, early retirement may be some issues. But Powell eventually acknowledged that PUA may be a factor behind low levels of labor force return to work (as some people are earning higher through generous PUA by not working and thus unwilling to get back work). Powell pointed out as PUA will expire by Sep’21, it will help higher labor force participation after that, which will address the present issue of demand/supply mismatch.

On any possible shoot-up of inflation far above +2% for a relatively long period, Powell said the Fed will use its tools to bring inflation back to 2%. Powell also pointed out higher possible inflation in the coming days because of the lower base effect, demand & supply mismatch, and higher energy/oil/commodity prices, etc. Powell thinks both of these two factors are transitory and thus Fed will be neutral on such inflation spikes. But if inflation materially stays ell over +2% for a relatively long time, the Fed has to use its tools to address that properly; i.e. Fed will go for a pre-mature hike to bring inflation back to target.

A few weeks ago, Powell said the Fed needs a string of months of around 1M job creation to achieve progress of its maximum employment goal. On Wednesday Powell was asked about the definition of ‘string of months’ (after close to 1M job creation in March). Powell said he was suggesting more like March job additions as U.S. has still 8.5M unemployed people compared to pre-COVID levels.

On China’s launch of CBDC (central bank digital currency) and slow movement of U.S. in this respect, Powell clarified the Fed/U.S. is not scrambling for the same as USD is and will be the king (global reserve currency). But Fed is considering some tech and policy issues before launching such CBDC, which will be primarily a technology for instant fund transfer from mobile.

On Fed’s new approach about inflation expectations - Powell reiterated it as +2.0% and average core PCE inflation at +2.0% over some time.

On any particular number of core PCE temporary spike, for which Fed will react-Powell virtually admitted Fed has no idea. And Powell again pointed out such spike would be largely transitory due to lower base effect, supply line issues (bottleneck effect), pent-up demand, etc. Although the Fed is sure such temporary spikes will eventually retreat, but not sure when (about timing). Powell also pointed out higher economic activities after reopening will demand higher demand amid fiscal as-well-as monetary stimulus. But at the same time, supply line bottleneck issues, especially for the consumer-facing service industry will take considerable time (few quarters) to readjust in the new post-COVID world. So until then, Fed may wait for any transitory spikes in inflation to return to normal.

Powell was asked about financial stability risk amid some recent issues like GameStop, Dogecoin, and Archegos hedge fund fiasco and whether such risks are a result of the Fed’s easy money (QE-4) policy. Powell said although some sections of the equity market are a bit frothy, the Fed is very careful about overall financial stability and sees no red line there. Powell also pointed out although monetary stimulus is part of a story of the sky-high equity market, the main boost is coming from the rapid progress of COVID vaccinations (herd immunity) and the reopening of the economy. Also, households are in good share due to stimulus checks (CARES Acts). The Fed is now mainly concerned about those 8.5M jobless people, mostly from the consumer-facing service industry, who had jobs before COVID in Feb’20, but now don’t have.

Powell was also asked whether Fed will further reduce IOER to reduce money market rates (bond yields)-Powell explained there is no need as the money market conditions are fine now. And money market rates may go further downwards because of Fed’s QE.

Powell was asked about financial stability risk due to possible overheating of the economy as a result of the deluge of stimulus and any requirement of higher regulatory capital for banks & NBFC. Powell said U.S. banks are well-capitalized over the last decade (after 2008 GFC) and the Fed is not concerned about U.S. banks. The Fed is now concerned about maintaining U.S. treasury market integrity and dealer’s capital position so that they could absorb any unusual treasury selling at a time of distress like during Mar’20 COVID times, when several foreign central banks sold U.S. treasuries. And eventually, Fed has to step in, start unlimited QE. And Powell also pointed out banks should stand on their own feet rather than hoping to bail out every time by Fed or some other central banks.

Powell was asked:

·         Whether Fed is thinking of some QE tapering amid the progress of COVID vaccinations and reopening of the economy?

·         Whether Fed allows the economy to stand on its own feet rather than being too much dependent on monetary and fiscal stimulus?

·         Whether Fed wants fiscal spending despite risks of higher inflation even after considering the transitory factor?

Powell reiterated the Fed will continue the QE at the present pace until its sees ‘substantial further progress’ of its dual mandate and the Fed will intimate the ‘public’ (Wall Street) well in advance about any normalization plan. Although full herd immunity (COVID) is not an official precondition, the full economic recovery is also dependent on the course of the virus and vaccinations.

Regarding the requirement of further fiscal stimulus, Powell repeated that it’s the prerogative of U.S. Congress (elected lawmakers) and Fed is not an advisor to Congress for this issue.

Powell was asked about the Fed’s continuance of MBS purchase $40B/month despite the hot housing market and whether such buying is causing further price hikes for homes. Powell pointed out Fed’s MBS purchase is intended to support the overall dysfunctional money market during Mar’20 COVID disruption and not to provide any direct support for the housing market. The U.S. housing market is now very strong, but being a very important part & parcel of the overall money/funding market, MBS has its importance and thus Fed is buying for the sake of systemic financial stability. But the Fed will eventually taper those MBS buying to zero when the appropriate time comes.

Finally, Powell was asked whether Fed is afraid of any taper tantrum or fears that there are not enough buyers for U.S. Treasuries in the money market for which the Fed is now ‘not thinking about thinking of tapering’. Powell made it clear that Fed wants ‘substantial further progress’ of its dual mandate from its Dec’20 meeting levels. Although the Marc’21 job report is great amid the progress of COVID vaccinations, it’s not enough and does not constitute even close to ‘substantial further progress’ from Dec’20 levels. And the Fed will now act on actual data, not mere forecasts.

Powell also made it clear that for any policy normalization, the Fed will do some stress tests to ascertain the impact of any QE tapering and gradual rate hikes on current easy financial conditions. If those test results are satisfying along with ‘substantial further progress of the Fed’s dual mandate, the Fed will go ahead for normalization like post-2008-GFC

Fed Chair Powell played by the known script but looks tired of repeating the same narrative that for any talks of QE tapering, the Fed will like to see ‘substantial further progress’ of Fed’s dual mandate (maximum employment and 2+% inflation (price stability) from its Dec’20 levels.

In Dec’20, the number of nominal unemployed persons in the U.S. was around 10.74M; unemployed rate 6.8% against 9.71M in Mar’21, unemployment rate 6.0%. In Feb’20, before COVID, the number of unemployed persons was around 5.79M, while the unemployment rate was at 3.5%, at 50-years low. So, in that sense, the U.S. economy needs to produce/restore around 3.92M jobs in the next few months to reach nominal unemployment levels of Feb’20 (pre-COVID).

US Core PCE Price Index

On Friday (30th April), flash data shows the U.S. real GDP grew by +0.4% in Q1-2021 (y/y) against Q4-2020 contraction -2.4% and Q1-2020 growth +0.3%. The U.S. GDP is set to grow by around +2.3% (y/y) pre-COVID levels in H2-2021 as per the present trend.

U.S. Real GDP Growth

Overall at glance, the U.S. GDP was boosted by higher consumer spending due to CARES Acts stimulus checks, private capex, and government consumption & investment. Still, after almost $6T spending in COVID fiscal stimulus (CARES Acts), U.S. nominal real GDP just returned to the pre-COVID levels at around $19.09T from a low of $17.30T; i.e. recovered only around $1.79T. As most of the CARES Acts are grants, not capex, it just prevented U.S. GDP from further collapsing by stimulating mass-consumer spending due to additional stimulus checks.

Thus, Biden now trying to further stimulate the economy by investment-led growth (infra spending), following the Chinese model. China, after growing around +2.0% (against U.S. contraction -3.5%), grew +18.3% in Q1-2021 against U.S. +0.4%.

The U.S. vaccinated almost 32% of its population till April from mid-Jan (around 3.5-months); i.e. almost 9% in a month. Looking ahead, even at the present run rate of around 10% per month, the U.S. will be able to vaccinate 80% of its population by Dec’21 to achieve sustainable herd immunity. And even before that with over 50% vaccinations (like Israel), the U.S. will be able to significantly open its economy (including consumer-facing service industry) by June’21 amid workable herd immunity (as around 20% of the public should have natural immunity).

Thus by Mar’22 or even before that, the U.S. unemployment rate may fall around 3.5% and core PCE inflation may hover consistently around +2.00%. And theoretically, Fed has to start its QE tapering by then. But Fed has already changed its dual mandate goalposts to keep U.S. borrowing costs lower for longer, at least till 2023-24 to fund huge COVID/fiscal/infra stimulus, so that overall interest on debt stays below 15% of revenue (red line). Fed/U.S. Treasury is now emphasizing on nominal debt interest/GDP ratio than nominal debt/GDP ratio to justify increasing U.S. fiscal stimulus and debt.

Biden admin will have to pass $2.25T infra stimulus bill by July-Aug’21 (FY21 period) and $1.80T social security package by Mar’22 (FY22 period and before U.S. mid-term election), so that U.S. treasury could tap the money market for over $4T new debt at lower borrowing costs (before Fed indicates of any QE tapering and gradual rate hikes). Thus whatever may be the FOMC narrative, Fed has to wait for normalization till U.S. Treasury issues fresh debt to fund Biden’s new fiscal stimulus of $4T to rebuild America.

Thus Fed may take the excuse of fragile economic recovery in Europe and Asia (slow COVID vaccinations), lack of tight labor market in the U.S. (muted wage growth, inequality, etc), and transitory spikes in inflation. And Fed may go for gradual QE tapering from Dec’22 and rate hikes from Dec’23. For that Fed may indicate and starts preparing the market for the eventual normalization from at least 3-months in advance; i.e. by Sep’22. Fed/Powell will now try to desperately defend Fed position at least till Dec’21 until U.S. COVID vaccinations get complete and there is visible flattening of the COVID curve. In its Dec’21 dot-plots, Fed may show one rate hike by Dec’23 and will also start thinking about QE tapering.

Bottom line:

The market was expecting some hints from Powell about QE tapering in the April meeting as Fed may go for the same by Dec’21. But despite repeated grilling by the press, Powell was firm in his stance that the Fed will go for QE tapering only after ‘substantial further progress’ of its dual mandate; i.e. maximum employment and price stability.

Although U.S. employment has improved remarkably in recent times, it’s still not ‘substantial’. And Fed will go for gradual rate hikes when it feels the labor market achieves maximum employment under the evolving economic situation (as per Fed’s assessment) and core PCE inflation is at +2.0%, on the course of going ‘moderately’ higher to +2.50% (?) and stay there for some time (to make up past underperformance-catch up inflation). Powell also reiterated that any increases in inflation are likely to be transitory and would ease after supply chain issues subside.

Bur despite more dovish hold and Powell ‘put’, USDJPY recovered as the market still believes QE tapering by Fed from Dec’21. USD is also getting a boost of higher bond yield amid talks of more fiscal stimulus by Biden and the eventual supplies of more debts.

Technical View: USDJPY

Technically, whatever may be the narrative, USDJPY now has to sustain over 109.25 for the next leg of the rally; otherwise may correct.



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