The gist of the December Fed Policy Statement
Needless to say, the Dec-20 Fed statement continues its focus on the troika of low rates, abundant liquidity and growth push. Here are 6 Key inferences from the statement.
- The Federal Open Market Committee (FOMC) will continue to support the functioning of financial markets and also stimulate the economy through open market operations. The Fed is reconciled and even comfortable with a bigger balance sheet.
- FOMC is open to expand its current monthly purchase of agency debt and MBS to support markets. Fed has committed that it would also be willing to expand the quantum and the duration of such bond purchases, if required.
- It follows logically from the previous point that the Fed is willing to even buy longer term treasury securities if the conditions warranted. In short, the Fed has almost stated that neither size of balance sheet nor duration of bonds will be a roadblock to liquidity.
- Fed has indirectly committed that it would be willing to print money and expand the liability side of the balance sheet as long and as much as required. This is evident from the fact that the assets side has been consistently expanding.
- The Fed statement is clear that it will influence the short end as well as the long end of the yield curve. Once the 2 points are established on the yield curve (long and short), the yield curve more predictable, substantially reducing uncertainty in financial markets.
- Fed has also implied that it will keep inflation expectation from creeping into pricing of longer-term bonds. That means the 10-year yields on US Treasuries will continue to remain in the 0%-1% range with a bias below the median. The Fed is essentially inviting investors to come and take risk with the assurance that bond yields will remain low.
Anything and everything for growth
This is, in a nutshell, an aggressive Fed statement. It has almost said that the Fed will do anything and everything in its powers to achieve 3 things. Firstly, it will keep liquidity abundant in the system for as long as required, at least till growth is decisively back.
Secondly, growth has already taken precedence over price stability and that will continue. However, inflation and jobs will not be a deterrent for policy accommodation. Lastly, the policy acknowledges the uncertainties and X-factors along the way as the trajectory of growth will largely depend on how the virus evolves. In this era of economic uncertainty, the best the Fed can do is to sustain its focus on abundant liquidity and low rates.
The liquidity support and the balance sheet expansion do appear to be substantial. For example, the policy clearly states that the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency MBS by at least $40 billion per month. These will not change unless there is evidence of sustainable inflation and job creation closer to the erstwhile full-employment levels of 95%.
What does the Fed statement mean for India?
For the Indian markets there are 3 very important takeaways from the Fed statement. Firstly, the bond yields in the US will remain low; not only because rates will remain low but also Fed will tweak yields lower. That takes away the immediate risk of unattractive real rates in the Indian context.
Secondly, The Fed has almost committed to keep the liquidity taps flowing. The 18% rally in the Nifty since November has been driven by too much liquidity turning FPIs risk-on. That looks set to continue. Thirdly, US growth is not coming back in a hurry and so the dollar will remain under pressure. That should be good news for the rupee.