In the World Economic Outlook, April 2021, an International Monetary Fund (IMF) research found that for emerging markets, what matters is the basis on which interest rates are increased. The research mentioned the following bases:
Federal Reserve officials accelerated their pace of policy tightening and raising interest rates by late 2023, sooner than they earlier expected, amid heating inflation and recovering labour market.
Fed’s median projections showed 13 of 18 board members expect the interest rate to rise to 0.6 percent by the end of 2023. Seven of them tipped the first move in 2022. Earlier in March, the central bank had expected to hold it steady throughout 2023.
At the end of the two-day FOMC meeting, Fed Chair Jerome Powell said that officials would begin discussing the bond-buying program. But, he gave no sign when Fed will begin cutting back the purchases.
“The economy has made progress,” Powell said adding, “You can think of this meeting as the talking-about-talking-about meeting if you like.”
The Fed maintained its easy monetary policy, keeping its benchmark interest rates at near zero, where it’s been since March 2020. It also maintained the pace of its massive bond-buying program -- spending $120 billion in treasury bills every month.
Fed wants the economy to get closer to their goals of sustained inflation and maximum employment before tapering the bond purchases, officials said.
: Fed raised its headline inflation expectation to 3.4 percent – a percentage point higher than March. This increase came after May inflation reading rose to a 12-year high. Yet, Fed maintained that inflationary pressures are ‘transitory’.
Fed still sees inflation within its 2 percent goal over the long run. But it is worried. If inflation exceeds 2 percent for a long time, market participants might come to expect more of it. The expectations will keep fuelling inflation if that happens.
“Our expectation is these high inflation readings now will abate,” Powell said. But he also pointed reopening economies “are raising the possibility inflation could turn out to be higher and more persistent than we anticipate,” he said.
It may cause Fed to tighten the policy. “We wouldn’t hesitate to use our tools to address that,” Powell said, “Price stability is half our mandate.”
He also cautioned markets not to read too much into the median projections. “It is not a great forecaster of future rate moves,” Powell said, “Lift-off is well into the future.”
GDP: Fed also increased GDP expectations from 6.5 percent to 7 percent. Powell said the indicators of economic activity and employment have strengthened due to rising vaccination. The sectors affected by pandemic are weak, but they have shown improvement, he added.
Some indicators show, in some respects, the US is expanding at the fastest rate since World War II. But this growth has come hand-in-hand with higher inflation.
Others: Fed kept the unemployment rate unchanged at 4.5 percent. It also announced extending dollar-swap lines with global central banks till the end of the year.
A dollar-swap line is like an emergency pipeline of dollars in countries that need them. The Fed “swaps” the dollar with the country's currency. It is one of the COVID-era initiatives the Fed took to keep global markets steady.
Global Markets react
Markets moved quickly to price in the risk of earlier Fed action. S&P 500 lost 0.5 percent and DJIA fell 0.8 percent.
Fed fund futures shifted to imply the first hike by 2022. Yields on 10-year bonds shot up almost nine basis points to 1.57 percent.
The dollar surged sharply higher, rising 0.9 percent overnight for its biggest gain since March 2020.
Rising bond yields and dollar served a double blow to gold, which slid 2.5 percent overnight.
Asian equities fell to a three-week low on Thursday. MSCI's broadest index of Asia-Pacific shares sans Japan was down 0.6 percent early morning – its lowest since late May.
Powell also maintained he plans to give markets plenty of advance notice before cooling down on the asset purchases.
“We will do what we can to avoid a market reaction, but ultimately, when we achieve our macroeconomic goal, we will taper, as appropriate,” he added.
Rob Subbaraman, head-global macro research at Nomura believes we could see a snapback in the US treasury yields.
“It’s clear from the FOMC meeting Fed is starting to turn a bit more hawkish and the risks, going forward, are that tapering and rate hikes could be brought for more, and so the risk is that at some point of time, we could have a snapback higher in US treasury yields,” he said.
In fact, Arvind Sanger of Geosphere Capital Management believes 10-year may hit 2 percent.
“I will be a bit patient but I am not panicking. This is inevitable; at some point, rates are going to rise and at some point, the 10-year yield is going to go at 2 percent, not in the near-term but it is going to get there as we normalise in the economy.
A few days back, I had said that inflation is going to be wrong, but what we saw from the Fed (at policy meet) is some recognition that inflation is there, and they can stay accommodative at the level that they have been during the crisis period of COVID last year.”
– With inputs from agencies