In a joint appearance with U.S. Treasury Secretary Janet Yellen at a U.S. Senate hearing on November 30, Federal Reserve Chair Jerome Powell said that the Fed may discuss accelerating the tapering of bond purchases at its next meeting due to the strong performance of the U.S. economy and the persistence of significant inflationary pressures. This new statement implies a change in the Fed's monetary policy, that it is accelerating in the direction of monetary tightening. This in turn, has multiple implications for the United States and the rest of the world.

For Powell, this change in attitude means that the Fed's monetary policy will be more catered to the U.S. Government. After getting re-elected as Fed chair, Powell's change in attitude shows that he has unloaded his baggage and is unwilling to be swayed by the market, which also shows that he is politically following the Biden administration's lead. With the rising inflationary pressure in the U.S., this issue has actually ceased to be an economic issue and evolved more into a political one. The Biden administration needs to prove that it is an effective government in maintaining price stability and the interests of the people before the midterm elections, as evidenced by the U.S. calls for OPEC+ to increase production and oil-consuming countries to release strategic reserves. As the official in charge of monetary policy, this statement by Powell is actually in line with the expectations of the U.S. government.

At the same time, as Powell indicated, now it is the right time to change the attitude. This actually refers to the emergence of Omicron variant of the novel coronavirus, which has changed expectations for the future of the economy. The general market view is that the new variant may slow the economic growth, dragging down the process of supply chain recovery, and making inflation will last longer. This new circumstance gives Powell a reason to make timely changes, avoiding the loss of credit from Fed policy adjustments and the embarrassment of previous errors in judgment. Some analysts have commented that the redefinition of inflation as ‘non-transitory' is not only sensible and reasonable, but also a sensible and cost-free political move. After all, inflation has become a common preoccupation of the average Americans and Wall Street alike. While dropping the “transitory” tag, Powell reiterated his expectation that inflation will fall next year because some of the factors contributing to higher prices can be traced back to supply and demand imbalances caused by the COVID-19 pandemic.

Contrary to market expectations, most market participants believe that the economic recovery process is being hampered as the outbreak continues, delaying the pace of the Fed's tapering of easing and rate hikes. Powell also said that the Omicron mutant strain and the recent increase in COVID-19 cases pose downside risks to U.S. employment and economic activities, and increase uncertainty about inflation. Contrary to expectations, Powell said the Fed may discuss accelerating the scale of bond purchases at its next meeting. He also stressed that tapering of bond purchases should not be seen as a sign that a rate hike is imminent. This attitude implies that in the coming period, the Fed's monetary policy objectives will shift from focusing on employment to focusing on currency stability, thereby addressing increasingly significant short-term inflation risks. In fact, as far as dollar liquidity is concerned, the current increase in the size of the Fed's reverse repo has shown that the market is already saturated with dollar liquidity, and the positive impact of eased monetary policy on the economy is becoming weaker and weaker, making it difficult to support the economy even if it slows down in the future.

This unexpected change brought a huge shock to the U.S. capital market. U.S. stock markets fell sharply immediately after Powell's speech, closing the day with the Dow Jones down 1.86%, the Nasdaq down 1.55% and the S&P 500 down 1.9%, while the dollar index rose to a high of 96.65. Oil price declines also intensified further, with WTI crude falling 4.58% by the close of trading; Brent crude futures once plunged more than 7% to close down 4.54%. Despite this, federal funds rate futures showed a return to rate hike expectations for June next year, which is not a big change from what was expected before the Omicron variant’s outbreak. For U.S. stocks, the change in Fed policy is not exactly bad news in anticipation of a stronger dollar and a return of international capital. However, the already highly bubbly market is actually in a very sensitive period, and any uncertainty could cause significant short-term volatility in U.S. Stocks. From the current situation, the U.S. market may still overreact, indicating that confidence in the U.S. market is still very fragile.

For international markets, this will bring the trend of capital flowing back to the United States; for emerging markets, they are facing the test of "tapering panic". At present, the Fed has not made substantive policy changes, and the Asian and European capital markets’ reaction has not seen big shock. Due to the different processes of economic recovery, the European Central Bank and the Bank of Japan still take a wait-and-see attitude, continue to release liquidity to give the market financial support. These circumstances make the capital markets of developed economies to still be able to hedge against the short-term impact of the expected changes in Fed policy. Future changes in international markets though, will still depend on several factors: first, the development of the pandemic; second, whether the Fed will take action to accelerate the tapering of bond purchases; and third, the progress of the implementation of the new stimulus plan of the Biden administration in the United States. That said, the most crucial element is the future changes in inflation trends under the influence of various factors, and the changes in inflation will also affect other major economies, who may follow the Fed's policy trend of tapering easing one after another.

For China, the Fed policy change is not expected to have a major impact in the short term yet, as China has taken stricter preventive measures to basically maintain the stability of its domestic economy and capital markets. In the long run, the fall in energy prices brought about by the strong dollar will reduce the pressure of imported inflation. China's central bank will continue to adhere to policy tone that emphasizes on stability so as to ensure its domestic economy can continue to enjoy the so-called "pandemic dividend". The most important of these is to keep the RMB exchange rate stable in order to build a firewall against changes in the external environment.

Final analysis conclusion:

In his latest speech, Fed Chair Jerome Powell has changed his views on inflation and strengthened his expectations of accelerating the reduction of easing. The trend of the world economy and capital market remains unclear, and there are still many uncertain factors. One thing however is sure, that inflation will increasingly become the focus of various contradictions.