Key takeaways from Powell: He would be concerned about (1) disorderly market conditions and a (2) persistent tightening in broader financial conditions. He noted that rapid increase in real rates is “something that caught his eye” – the reason is that it is not the level of rates but the pace at which rates increase that impacts economic activity. In the US, mortgage bond rates are priced from the US T curve, unlike in SA where the repo rate is the key interest rate. He added that “it’s not appropriate to isolate one particular interest rate or price”. He is looking at broader financial conditions (see charts below) and disorderly markets can lead to a tightening in conditions (as in March/April 2020). Further, the expected increase in inflation in the coming months is expected to be transitory (coming from a low base and higher fuel prices) as global disinflationary pressures would contain inflation going forward. Again, Fed tapering would be communicated well in advance. But what roiled the markets was that no measures/intentions were announced in the context of the increase in recent market volatility in US Treasury yields. So important dynamics to monitor are (1) how the US equity market is going to respond to a higher discount rate and (2) incoming activity indicators that can have an impact on corporate spreads which in turn can affect cash flows ; (3) the direction of the USD (the rest of the world is comfortable with a stronger USD as weaker currencies support growth); and (4) the direction of inflation.
Financial conditions are influenced by a wide range of variables: i.e. short rates and availability of liquidity, the slope of the sovereign yield curve, corporate credit spreads, movement in equity price and the USD.