Why what happens in the US does not stay there

Tuesday and Wednesday saw the much-anticipated Congressional testimony of US Federal Reserve chair Jerome Powell and Secretary of the Treasury Janet Yellen.

The focus was on how much longer the Fed would continue with its dovish policy and whether the $1.9 trillion stimulus package risked overheating the economy leading to inflation. These discussions matter beyond the US.

Firstly, a look at how the testimonies unfolded: Powell assured lawmakers that he would continue the extra loose monetary policy for “as long as it took,” translating into bond purchases close to $120 billion per month and close to zero interest rates.

Economists, such as former Secretary of the Treasury Larry Summers during ex-US President Bill Clinton’s administration, and many Republican lawmakers are concerned that the latest stimulus package could overheat the economy.

Powell argued that even if inflation temporarily rose above 2 percent this would be transient. His concern, similar to Yellen’s, was low-wage workers, particularly minorities, whose jobs were disproportionately impacted by the coronavirus disease (COVID-19) pandemic. The unemployment rate of 6.2 percent remained elevated, despite monetary and fiscal measures cushioning the blow and keeping millions employed.

The Fed’s 2021 gross domestic product (GDP) growth forecast was up by 2.3 percent to 6.5 percent and lowered unemployment to 4.5 percent, down from 5 percent. The trajectory seems correct, as the week ending March 20 saw first-time jobless claims drop by 97,000 to 684,000.

So far so good. And it cannot be ignored that most of the 150 million Americans who received a cheque for $1,200 will get another one of $1,400 courtesy of the latest stimulus package, which will lead to more dollars chasing goods.

The latest IHS Markit US Flash March PMI (purchasing managers’ index) figures suggest that inflationary pressures exist. At 59, it is the highest in a decade – reflecting inflationary pressures, which were partly induced by supply chain shortages courtesy of US-China trade wars and COVID-19.

When Powell reaffirmed his intention to leave US rates at current levels through 2023, that was good news for emerging markets, which benefit from record low interest rates.

Cornelia Meyer

Inflation is supply, rather than demand, wage growth not being of concern right now, which seems to support the Powell and Yellen argument of the transient nature of inflationary pressures.

When Powell reaffirmed his intention to leave US rates at current levels through 2023, that was good news for emerging markets, which benefit from record low interest rates.

Back in 2013, the Fed’s rise in interest rates resulted in the famous taper tantrum, which had devastating effects on emerging market currencies and stocks. In 2021, what matters is not only the requirement to monitor where interest rates are, but also the yield of US treasuries.

The yield of the 10-year note rose from 0.9 percent in January to a 14-month high of 1.75 percent, recently coming down somewhat. This matters to Gulf Cooperation Council (GCC) government bonds, because the higher the differential to the “gold standard” treasuries the more appetite for GCC debt – the GCC currency peg to the US dollar furthermore eliminating the exchange rate risk.

In that sense, Wednesday’s auction of the US five-year note worth $62 billion was good news. The yield was 0.85 percent – only 3 bps (basis points) above the yield set prior to the auction was good news compared to where things stood earlier in March.

All eyes will be on Thursday’s $62 billion seven-year note and whether it will be able to improve on the difficult auction, which preceded it.

To sum things up, the recent central bank and treasury statements in the US did a lot to assuage fears of international investors that persistent inflation was imminent and that a change in expansive Fed policies should be expected.

In turn, this helped emerging markets and the yield differential of any debt they intend to issue, which works particularly well when currency fluctuations can be taken out because of the peg as is the case in the GCC.

 

• Cornelia Meyer is a Ph.D.-level economist with 30 years of experience in investment banking and industry. She is chairperson and CEO of business consultancy Meyer Resources. Twitter: @MeyerResources