Despite the Delta-driven surge in virus cases, economies are now looking at suitable policy measures to sustain a post-COVID scenario marked with rising interest rates and tapering of bond purchases. Speculations are rife about policy tightening being the next move that central banks across the world can embrace to fight inflation and reduce market uncertainty. In fact, central banks of the United States and Australia have expressed their approval for bond tapering measures, though with different execution timelines.
Bond tapering can be broadly understood as the scenario opposite to Quantitative Easing. It is generally adopted to gradually wean off from the monetary stimulus provided during stressful times. Both the US and Australia opted for generous monetary easing programmes in the pandemic era, including massive bond purchases.
The central bank heads of both the RBA (Reserve Bank of Australia) and Fed have turned economists’ heads with their unexpected take on monetary tightening measures in their latest announcements. While the RBA has decided to go ahead with tapering bond purchases from early September, the Fed continues to sit on the fence regarding its decision.
Notably, tapering measures have already taken shape in Australia, with the RBA announcing in early August that it would trim bond-buying to AU$4 billion in September despite ongoing lockdowns. On the contrary, the US Fed has made no concrete moves yet in the same direction.
How long could Fed’s delay hold up?
The rising inflationary pressures have surprisingly not affected the Fed’s tepid stance on the issue of monetary easing. While the annual US inflation rate hit 30-year high level in July 2021, the Fed has not budged from its decision to continue with bond purchases.
The Fed officials are still mulling over the timeline of tapering bond purchases, which depends on how the economy evolves. In a seemingly confident statement, Fed Chair Jerome Powell recently pointed that the US economy could quickly recover its lost ground.
Mr Powell believes the economy is clearly on a path to a very robust labour market with high workforce participation. However, ongoing unemployment benefits, as well as disruptions caused by the virus, have also played a significant role in leading up to the current labour market conditions, a factor often overlooked by Chair Powell in his announcements.
While experts suggest that tapering is a crucial move to step out of recovery, its impacts might heighten uncertainties for consumers. With tapering, mortgage rates may experience a tug of war alongside tightening measures, influenced by varying levels of inflation. If inflationary pressures are regulated and well-maintained, mortgage rates may remain low. However, if higher inflation is sustained and the tapering process is fast, mortgage rates could shoot up.
Thus, consumers and investors could experience a period of volatility post a taper, with different forces possibly changing the game for economic recovery. Meanwhile, a concrete stance by the Fed on bond tapering could see some daylight amid rising cases of the Delta variant, which could potentially cause economic distress in the country. This may prompt the central bank to delay its bond tapering decision further.
Will the RBA stick to its bond tapering decision?
Australia is currently locked in a unique situation, where the expected tapering could interfere with the ongoing halt in economic activity due to lockdowns. The prevalent lockdowns could once again cause a void in economic activity and pull the brakes on the ongoing recovery. This projection is especially significant, given that the RBA’s taper may effectively have a similar effect on the economy.
More worrisome are the forecasts rolled out by economists stating that the RBA’s predicted 4 per cent economic growth rate is becoming increasingly unattainable. If present conditions persist, there is a high likelihood of the economy experiencing a contraction. This may convince the Australian central bank to rethink its bond tapering decision.
Notably, the central bank has promised to extend support in case the circumstances become chaotic. At present, there remains a question mark on the RBA’s future course of action regarding the bond tapering aspect. It will be interesting to see in the coming weeks if the taper will appear with some adjustments, or the RBA will retain its current policy stance.
The implications in the current period
The uncertain trajectory of the COVID-19 virus has translated into an ever-changing economic scenario, which needs swift action and a flexible policy structure. Central bankers may have to continue taking cautious strides even after they are out of recovery mode. In the pandemic era, the central banks have constantly evolved with the changing pace of economic recovery.
Meanwhile, the varying circumstances have created uncertainties regarding the interest rates, labour market conditions and the health situation in both the US and Australia. In the coming weeks, equity market participants may also see heightened volatility as crucial decisions await the course of stock market activity.
With taper talks progressing like never before, activities in the coming months are expected to set in motion the long-term growth trajectory for the Australian and the US economies. In the given scenario, the intensity of inflationary pressures could alter these economies’ response to the central banks’ policy actions.