FOMC, NFP and Quentin Tarantino

FOMC decision is out, it was out on Wednesday itself but yesterday being a holiday in India we were not able to cover the same. On the expected lines the taper has started but not the 20 Bn USD per month which the market was pricing in but 15 Bn USD. There also the element of discretion has been kept as the pace of purchase reduction can be changed (shifted up or down) depending on the evolving economic conditions. The message was clear that the SFP test (substantial further progress) has been met for the taper but for hiking the rates the test is much more stringent and no comments can be made as of when that will be met.

Apart from reading the policy statement which is there on the FOMC website, the Fed Chief's press conference is one thing which everyone interested in economics should mandatorily watch. The range of questions possibly cover all the open threads and provide clarity. There is a moment in the press conference where the Fed Chief takes almost two minutes to describe and elucidate the word "transitory". It is a masterclass in communication, he explains that the common understanding of the word entails that "transitory" means short lived that is there is an element of time attached to the word but in case of Fed when they used transitory they mean that the inflation won't leave any structural effect behind it. The current inflation is due to supply bottlenecks and sudden increase in demand which will solve itself out over a period of time. This time period is highly uncertain as of now it looks that it will continue to be in place well into next year.?

There was a question whether the Fed is sacrificing the inflation goal at the altar of achieving maximum employment. Essentially the cost of bringing the 5 million people (compared to pre-pandemic level) back to the employment fold is being paid by everyone in the general public in terms of high inflation. Powell's response was instructive as he clarified that what the reporter is referring to is a wage price inflation that is an inflation which happens because a very supportive job market results in demand for higher wages which ultimately results in companies increasing the price of their goods to maintain the profitability, a classic Philips curve insight. As per Fed this is not the case right now and current inflation is more a supply disruption phenomenon. A wage rise induced inflation will be more structural in nature and cant be deemed transitory as per Fedspeak.

Fed is also watching multiple markers for gauging their maximum employment target, the 5 million number remains only of them. Today we will have the NFP report where the expectation is that the economy will add 450k new jobs in the month of october. Unemployment rate is expected to be around 4.7%. Maximum employment anyways is a fuzzy goal which involves computing maximum potential output of the economy then comparing it with the current output and determining how many people need to enter the labor force to close the slack. All these goals and outcomes only are clear in the hindsight mirror. Policy makers however are expected to know better than the general public, Fed employs more than 2000 Phd warriors armed with economics and statistics weaponry.?

Coming back to the Fed decision to taper,it would be instructive to have a look at the sequence of events last time when the taper happened. The FOMC first slowed the pace of large-scale asset purchases (LSAPs) in 2013, then raised the federal funds rate above the effective lower bound in 2015, and finally started reducing the balance sheet in 2017. It was taper, liftoff and QT (quantitative tightening). The lift off and QT both ultimately tighten the credit conditions but target different parts of the yield curve. Lift off as it reckons with raising the overnight rates only slowly filters into long term rates and sometimes create a yield curve inversion if the future economic prospects are not that good. Deliberate QT on the other hand impacts the long term yield much more pointedly. QT also refers to Quentin Tarantino, it is not a wonder that economics these days looks more like pulp fiction.