Fed hints at zero level rates for the next three years

It must be remembered that earlier in August, the US Fed had also brought out its Long Term Policy paper, which had already given an indication that rates status quo would be maintained, irrespective of temporary spikes in retail inflation.

Sep 18, 2020 08:09 IST India Infoline News Service

The Federal Open Market Committee (FOMC) concluded its 2-day meeting on September 16, 2020 and there was little by way of surprise. The US Fed almost confirmed that rates would stay in the range of 0.00% to 0.25% for the next 3 years. That takes away any uncertainty about US monetary policy. It must be remembered that earlier in August, the US Fed had also brought out its Long Term Policy paper, which had already given an indication that rates status quo would be maintained, irrespective of temporary spikes in retail inflation.

Key takeaways from the 2-day Fed meeting

While the interest rate confirmation was what the markets awaited, there was also curiosity about how the GDP outlook for the US economy and the Fed balance sheet would pan out.

• Broadly, the US Fed kept its pledge to hold interest rates anchored near zero and promised to keep rates there until inflation was consistently higher. The focus here is on the word “consistently”. Unlike in the past, the Fed would only be bothered about a secular uptrend in inflation; not temporary spikes.

• The projections given by individual members were a lot more revealing. In fact, they indicated that the rates could remain anchored at the 0.00%-0.25% range all the way through 2023; the first time members have attempted to make such a long term projection of rates.

• It was also unprecedented in the sense that for the first time, the Fed affirmed that boosting the engine of US economic growth would take precedence over controlling inflation. That means; even if the inflation did breach 2% on the upside during this period, the Fed would not be too enthusiastic about hiking rates.

• Fed Chair, Jerome Powell, has termed this guidance as Powerful in his post-meeting conference. Powell also underlined that rates would remain accommodative until the economy was far along therecovery path. Even on a conservative basis, that would imply at least 10-12 quarters for the US economy.

• The GDP estimates of the Fed are a lot more interesting. The chart below captures the Fed estimates of GDP growth till 2023.

Chart Source: Federal Reserve and CNBC

The committee now sees a full-year GDP decline of (-3.7%) in 2020, but better than the (-6.5%)declineforecast in June. At the same time, Fed also expects the growth in the next 3 years to be less flattering. For example, the GDP growth for 2021 was lowered to 4% from 5% and for 2022 from 3.5% to 3%. The actual growth will determine the rate trajectory.

• The Fed has also lowered its jobless rate projection from 9.3% to 7.6%. But that was expected after August jobless rates came in at 8.4%. However, like in the case of inflation, the Fed has already confirmed that even if the unemployment rates were to go below 5%, the Fed would not be in a hurry to hike rates unless inflation supported.

• Fed has already unloaded an array of policy tools aimed at keeping the economy afloat and markets functional. It initiated lending and liquidity programs that coincided with a rally in stocks and a steadying in economic indicators.

• Treasury yields moved higher after Powell said the Fed plans to keep its asset purchases at current levels. Bond market analysts and traders have been expecting the Fed to increase Treasury purchases but Powell did not commit to that. Here is why.

Chart Source: Bloomberg

As the chart shows, the total size of the Fed balance sheet is close to $7 trillion. That is virtual doubling of the Fed balance sheet in the last 4 months. At the current level, the Fed balance sheet is nearly 2.4 times the peak level of the balance sheet after the Lehmann crisis. While liquidity may continue to be critical, the Fed is gradually running out of liquidity creation capacity. Hence, there was little indication on adapting the bond program.

• Finally, we come to the issue of savers and borrowers in the US. Lower-than-normal rates are great for borrowing and refinancing. However, it is not good news for savers, especially for long term pension funds that are going to be left with a huge yield gap.

Takeaways for the Indian economy!

With the US running out of rate and liquidity options, the only consideration for India is; how long the US can hold low rates? The indications from the latest Fed policy are that low rates and ample liquidity are here to stay, at least till 2023. That gives the RBI more leeway to hold rates in the Indian context, or even nudge lower if inflation permits. Above all, the ample liquidity ensures that equity markets remain buoyant due to consistent flows from ETFs and global flows. That is the good news for India, notwithstanding valuation concerns!

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