The following article is from Zhong Zhengsheng Economic Analysis, author of Ping An Shoujing team
Authors: Zhong Zhengsheng, Zhang Lu, Fan Chengkai (Zhong Zhengsheng is a director of the China Chief Economist Forum, chief economist of Ping An Securities, and director of the Research Institute)
Event: On July 28, 2021, US time, the Federal Reserve released the statement of the July FOMC meeting, and Fed Chairman Powell was interviewed.
1. Monetary policy: The main monetary policy remains unchanged. There are only two changes in the monetary policy part of the expression, but both are technical adjustments and do not change the tone of monetary policy.
2. Wording of the statement: The statement's overall statement of the US economic outlook has not changed much, with two subtle changes: First, it weakens the role of vaccines. We understand that the main reason is that the recent decline in the rate of vaccination in the United States, the marginal effect of vaccines on the economy has weakened, and vaccines have difficulty completely stopping the spread of Delta virus. Second, it has weakened the impact of the new crown virus on the economy. The previous statement argued that the path of economic development in the United States would depend "significantly" on the impact of the new crown virus, and the wording was deleted from the statement. The July statement first mentioned "progress" but did not stress that the economy had not yet made "substantial further progress" (SFP). The previous statement stated that the Fed would continue to maintain asset purchases until it achieved SFP. The statement was a subtle change, similar to a first-half review that mentioned "since last December" that the Fed has made progress through asset purchases. The expression of "progress" (plus the expression of weakening the impact of the virus) once made the market feel "eagle gas": the dollar index rose short-term after the statement was released, jumping from near 92.50 to above 92.70; the US Treasury yield rose slightly from 1.25% to 1.26% in 2010. At the same time, the market also felt the confidence of the Federal Reserve in the US economy in the statement, and the three major US stock indexes all rose short-term.
3. Powell interview: 1) "Clarification" has not yet reached "further substantive progress" (SFP). "We are moving towards this goal, but we are still away from it." 2) About Taper and how to tighten monetary policy. Powell said that the QE will still be cut before the rate hike; the MBS and the national debt will be roughly similar, and if it comes to the time of the cut, it will be cut at the same time. 3) About inflation. The most asked topic at this press conference was inflation, highlighting the market's concerns about inflation. Powell responded with the aim of convincing that market inflation could still be "temporary." In addition, it stressed that if inflation indicators do continue to rise, the Fed will use "tools" to respond. In our view, the main goal of this formulation is to guide (lower) inflation expectations, not to imply that the Fed will rush to act to contain inflation. 4) About employment. Powell seems confident in his judgment of job prospects, using the phrase "very strong labor market," clearly on the path, and that it shouldn't take that long. After Powell's speech, the market felt a "dove" as he "clarified" that he had not yet achieved SFP: the dollar index plunged and fell below 92.3, below the level before the statement; the 10-year US Treasury yield slipped 3 basis points, falling below 1.23%; the spot gold price broke through $1805 from $1800. At the same time, Powell's "confidence" continued to pull up the three major U.S. stock indexes.
4. How to understand the Fed's "enigmatic confidence"? This time, the Fed's monetary policy is basically unchanged, and it does not give much information about Taper, which is basically in line with market expectations. But what doesn't quite match market expectations may be the Fed's "enigmatic confidence." Markets believe that the fed maintains its dovishness because the economy has not recovered well enough and the risk of the epidemic remains. But it's clear that the Fed's statement is the opposite. We believe that while there is a series of negative signals in the fundamentals of the US economy, the Fed has to express "confidence"! Not only will this boost market confidence, but most critically, the Fed needs to get the "wheels" rolling: in order to deliver on the promise of "no sharp turns," the Fed needs to unleash enough confidence in several important meetings in the future to pave the way to exit QE. The Fed has repeatedly stressed in recent times that it will give advance notice before announcing any changes to asset purchase decisions, and the "high degree of confidence" displayed by the Fed at this rate meeting may be part of this "notice".
We maintain our judgment that the "negative" information that currently exists in the U.S. economy will not cause the Fed to change the established rhythm of monetary policy normalization. It is expected that at the Jackson Hole Global Central Bank Meeting on August 26-28, and the FOMC meeting on September 21-22, the Fed will continue to provide new clues to pave the way for a formal announcement of discussions on Taper, while the official start of taper implementation may still be the end of this year or early next year.
1. Monetary policy: basically unchanged
Monetary policy in the July 2021 Fed FOMC statement remained largely unchanged: maintaining the federal funds rate (0-0.25%), maintaining the pace of asset purchases ($80 billion in Treasuries and $40 billion MBS per month), maintaining reserve rates (0.15%) and overnight reverse repo rates (0.05%), etc. unchanged.
In the monetary policy statement, there are only two changes, but they are technical adjustments and do not change the tone of monetary policy: 1) The new overnight repurchase operation rules are added, and the total amount of overnight repurchase operations with a minimum bidding rate of 0.25% is carried out, but this limit can be temporarily increased by the chairman's decision. 2) Announced that the Committee voted to approve a provision on reserve rates, which no longer distinguishes between the "Statutory Reserve Requirement Rate (IORR)" and the "Excess Reserve Rate (IOER)" from July 29, but instead uses the "Reserve Balance Rate (IORB)" uniformly.
2. Wording of the statement: For the first time, "progress has been made" and the impact of the virus has been weakened
The July statement's presentation of the U.S. economic outlook has changed little overall, with two subtle changes: First, it weakens the role of vaccines. The statement began with the statement deleting the phrase "progress in vaccination reduces spread of the outbreak.". We understand that the main reason is that the recent decline in the rate of vaccination in the United States, the marginal effect of vaccines on the economy has weakened, and vaccines have difficulty completely stopping the spread of Delta virus. Second, it has weakened the impact of the new crown virus on the economy. Previous statements argued that the path to economic development in the United States will depend "significantly" on the impact of the new crown virus. The current statement deleted "to a large extent", only to say that the economic development "continues" depends on the direction of the virus, which is more "understated". Beyond that, the statement retained much of what had been previously done, including attitudes toward inflation, which argued that the rate, while rising, still largely reflected "temporary factors."
The July statement first referred to "progress" but did not emphasize that the economy had not yet made "substantial further progress" (SFP). The previous statement stated that the Fed would continue to maintain asset purchases until it achieved SFP. The statement was a subtle change, similar to a first-half review that mentioned "since December" that the Fed has made progress through asset purchases.
The expression of "progress" (plus the expression of weakening the impact of the virus) made the market feel "hawkish": the dollar index rose short-term after the statement was released, jumping from near 92.50 to above 92.70; the 10-year US Treasury yield rose slightly from 1.25% to 1.26%. At the same time, the market also felt the confidence of the Federal Reserve in the US economy in the statement, and the three major US stock indexes all rose short-term.
3, Powell interview: "clarification" has not yet reached "further substantive progress", optimistic about employment, bullish inflation risks
After the JULY FOMC meeting, Powell's interview highlights included:
1) The "clarification" has not yet reached the "further substantial progress" (SFP). The first reporter asked whether there were specific numbers and definitions for SFP, powell said: The job market indicators are complex, such as unemployment rate, labor force participation rate, wages, etc., so it is difficult to give definitions and specific figures; we are moving towards this goal, but we are still away from it. Later, after another reporter asked a question, he again stressed that we are on the processnow, but not SFP.
2) About Taper and how to tighten monetary policy. Some reporters asked whether they would consider raising interest rates before completely cutting QE to curb inflation, Powell said that he would still cut QE first; some reporters asked whether he would consider reducing MBS first to control house prices (the market did have more speculation about this before this meeting), Powell said that the role of MBS and treasury bonds is generally similar, if it comes to the time of reduction, it will be cut at the same time.
3) About inflation. The most asked topic at this press conference was inflation, highlighting the market's concerns about inflation. In response, Powell has repeatedly explained that the main reason for the surge in inflation indicators is the rise in used cars, airline hotel fees, etc., and the main reason for these sub-increases is supply chain bottlenecks. Explaining so much, Powell aims to convince markets that inflation may still be "temporary." However, he acknowledged that inflation has not fallen as quickly, and it is indeed significantly more than 2% at present, but in the medium term, inflation is expected to return to normal. In addition, it stressed that if inflation indicators do continue to rise, the Fed will use "tools" to respond. In our view, the main goal of this formulation is to guide (lower) inflation expectations, not to imply that the Fed will rush to act to contain inflation.
4) About employment. Powell seems confident in his job prospects, using the phrases very strong labor market, clearly on the path, and it shouldn't take that long. He believes that the current job market vacancies are high, mainly due to people's more cautious choice of new jobs, while worrying about the epidemic and the fact that many states are still paying high unemployment benefits have an impact on employment.
After Powell's speech, the market felt a "dove" as he "clarified" that he had not yet achieved SFP: the dollar index plunged and fell below 92.3, below the level before the statement; the 10-year US Treasury yield slipped 3 basis points, falling below 1.23%; the spot gold price broke through $1805 from $1800. At the same time, Powell's "confidence" continued to pull up the three major U.S. stock indexes.
4. How to understand the Fed's "enigmatic confidence"?
This time, the Fed's monetary policy is basically unchanged, and it does not give much information about Taper, which is basically in line with market expectations. The market does not expect the Fed to give much information about Taper, and the decline in US Treasury yields in the past 10 weeks (especially the record low in real interest rates) and the weakening of the DOLLAR index all indicate that the market predicts that the Fed's policy orientation is dovish. But what doesn't quite match market expectations may be the Fed's "enigmatic confidence." The market believes that the reason why the Fed maintains its dovishness is that the economic recovery is not good enough, and the risk of the epidemic remains. But it's clear that the Fed is saying the opposite — downplaying the impact of the virus, looking down on the impact of inflation, and expressing optimism about the job market.
One question worth pondering is why the Fed has been able to maintain a high degree of confidence in the economy, even with a series of negative changes in the U.S. economy recently. In our report, "What are the expectations for the Fed Interest Rate Meeting in July?" Since the Fed's June interest rate meeting, there have been a series of "negative" changes in the US economy and market environment: 1) the Delta virus has triggered a new round of global epidemics, 2) the US unemployment rate rebounded by 0.1 percentage points in June, 3) the US CPI in June continued to exceed expectations, and residents' concerns about inflation may be dampening consumer confidence, 4) Biden announced that the scale of infrastructure support has shrunk by about 40% compared with the original plan, and 5) long-end US Treasury yields have unexpectedly fallen to the low level in February this year.
We believe that while there is a series of negative signals in the fundamentals of the US economy, the Fed has to express "confidence"! Not only can this boost market confidence, but most critically, the Fed needs to let the "wheels" roll up. In order to fulfill the promise of "no sharp turns", the Fed may need to complete several steps in the second half of this year: 1) "advance notice" that the economy is about to make "further substantive progress"; 2) announce formal discussion of Taper; and 3) announce the extent and timeline of Taper. In this way, "there is not much time left for the Fed", and the Fed needs to release enough confidence in the next few important meetings to pave the way to exit QE. The Fed has repeatedly stressed recently that it will give advance notice before announcing any changes to asset purchase decisions. The "high degree of confidence" shown by the Fed in this interest rate meeting may be part of this "notice".