Negative expectations ahead of the FOMC meet
Ahead of the FOMC meet on March 16 and 17, global markets were nervous that the US Fed could change its accommodative stance. There were 3 negative expectations ahead of the FOMC meet.
- The markets were factoring in a remote possibility of a 25-bps rate hike and a high probability that the Fed would guide for couple of rate hikes in 2021.
- The bigger concern was liquidity and the expectation was that the Fed may opt to go slow on the bond-buying program, currently at $120 billion per month.
- Lastly, there were fears that the FOMC might not do anything about the vast divergence between the Fed funds rate and the 10-year bond yields.
Chart Source: Trading Economics
Bond yields are normally considered to be a lead indicator of likely hikes in interest rates. Fed rates and bond yields had widely diverged since July last year. In fact, even as the Fed Funds rate stayed at 0.00%-0.25%, the bond yields rallied sharply from 0.51% all the way up to 1.67%, which is where it stands as of date.
To the credit of FOMC, it was categorical that the rates would not be hiked, at least, till 2023. The FOMC also committed to maintain the bond buying at current levels to support the revival in economic growth. However, the FOMC did disappoint by not outlining any strategy to address the dichotomy between Fed rates and bond yields.
What exactly did the FOMC announce on 17 March?
Fed policy statement made important points and the indications for global markets are positive.
a) The Fed has reiterated that its primary focus will continue to be on supporting growth in the US economy on a sustainable basis followed by full employment and price stability.
b) While inflation in the US is inching close to 2% (1.7% as of Feb-21), the FOMC statement has underlined that it would focus on sustained inflation; not inflation data points. The statement also highlighted the overt impact of oil prices on inflation, which the FOMC expects to moderate in coming weeks.
c) The FOMC has also included an extra condition that, apart from growth recovery, Fed would hold the accommodative stance till the time the lag effects of COVID were fully eliminated. That offers long-term policy clarity.
d) The FOMC opted to keep the Fed Funds rate in the range of 0.00% to 0.25% till outcomes like inflation, employment and growth were achieved on a sustained basis.
e) On timelines, the FOMC has reiterated that, in the normal course of things, it did not foresee any chances of a rate hike till the end of 2023. That is broadly in line with the long-term monetary strategy outlined by the Fed in Aug-20.
f) On bond buying, the FOMC has opted to maintain its current run rate of $80 billion per month of treasury securities and $40 billion per month of agency-backed securities. In addition, FOMC has committed to be flexible and amenable to increases if required. That gives a lot of liquidity comfort.
FOMC projections will be music to the ears of Indian markets
The economic projections made by the Fed Board are quite self-explicit.
|Macro Variable||Year 2021||Year 2022||Year 2023||Long Run|
|Real GDP growth||6.5%||3.3%||2.2%||1.8%|
|Fed Funds Rate||0.1%||0.1%||0.1%||2.5%|
Why exactly are these data points important to India?
- Firstly, outside of these projections, the Fed has committed to hold the $120 billion bond program and increase it, if required. Liquidity flows should remain robust.
- GDP spike in 2021 will be on a small base and the US economy will need substantial liquidity support to even achieve lower levels of growth after that. That means, the US would keep rates low and the stance of the policy accommodative.
- The Fed does not expect any runaway inflation in the long run, once the oil impact stabilizes. So, any price stability driven rate hikes are ruled out.
- Finally, the Fed has given a clear projection of protecting Fed rates at least till the end of 2023 and that should give comfort.