At the end of its two day meeting, the US Federal Open Market Committee had decided to continue with its current policy of Quantitative Easing of monthly bond purchases of USD 85 billion and refrained from announcing a reduction in the buying program or ‘tapering’. This was in a complete about-face from what it had said in its May meeting that it may resort of tapering of the bond purchase program.
The reasons given by the Fed can be summarized below:
- Elevated unemployment rate. The current rate of unemployment of 7.3% -7.5% was considered still too high for the economy to be considered to be out of recession. The Fed has indicated that unless this rate falls below 6.5% consistently, then only will it be considered to prune the purchase program.
- Economy on an steady growth phase and downside risks to the growth have diminished
- The recent tightening of the financial markets (rise in yields of all asset classes) was thought to have an opposite effect on the growth of the economy and a continued rise in yields might have a debilitating effect on the economy.
- The medium term inflation target is 2%, but current inflation below that trend could pose risks in the economy.
- Price stability and unemployment reduction being the mandate of the Fed, unless there is improvement in these areas, the Fed would desist from reversing its accommodative policy.
The US Fed had worried world markets, especially emerging markets, when they had spoken about tapering its bond purchase program in May 2013. Currencies worldwide took a beating especially the rupee which fell in value of about 20% against the dollar. The market expected that the Fed, even if they do not resort to tapering the bond purchase program would at least announce a calendar for the same. What had spooked the Fed to reverse its own thinking was the rise in yields across all asset classes in the interregnum since May. For example the 10 yr UST yield moved up from 1.6% to a peak of 3% before falling to 2.8%, the 30 year mortgage loan rising from 3% to 4.75%. These rise in yields increased costs across the economy which led to slower new housing starts and a lower rise in new job creations. Sensing that the economy is still too fragile, the Fed was forced to reverse its decision.
As we are reading the markets now, it is assumed that the US Fed would resort to thinking about tapering on in FY 2014, most likely after March 2014. The result in yesterday’s Fed decision resulted in the following movements:
- Indian Rupee moved up to Rs. 61.77 , a gain of 2.17%
- BSE Sensex moved up to 20,500 levels , a gain of 2.70%
- The Indian 10 yr Gsec yield is currently at 8.17% down from yesterday’s closing of 8.37%
- The 2 month /3 month CD levels are at 9.80% , down 60bp since yesterday
- The one year CD levels are currently at 9.65%-9.70% down 50 bps since yesterday
- In our markets we have the key RBI mid quarter monetary review meeting tomorrow. The markets are pricing in a cut in the MSF rate of about 50 bps from 10.25% to 9.75%. The reason being that since the Fed had gone back on the decision to reduce quantitative easing , then RBI would be forced to do the same.
- But the local conditions in the economy are far different. Inflation is up (WPI moved up while CPI was
- marginally down). CAD is still high, though imports have come down and exports are showing signs of improving. The key point here is that the RBI would not tinker with the key rates like Repo rate, CRR etc.
But the recent liquidity tightening measures introduced in July 2013 have impacted yields and consequently other economic activity. This would have an impact on the GDP nos for this quarter. However, RBI had maintained time and again that they would ensure that the monetary policy would ensure growth. Going forward, keeping in view the US Fed’s moves, the RBI would be forced to opt for some measures. The basic measures banks are asking for the reduction in the daily CRR maintenance levels from the current 99% and a partial cut in the MSF rates. Even if the RBI does opt for status quo and decides on a later date to roll back these measures, we do not see any further major spike in yields. The 10 yr G-sec has rallied 85 bps from the peak of 9% seen in mid-August. A status quo decision tomorrow may see yields move up 10-15 bps but in the short to medium tenure, we see yields eventually moving down. - Ganti N. Murthy Head – Fixed Income From the Equity Market Desk
The decision by the Federal Reserve to postpone the rollback of its stimulus measures was greeted by the markets worldwide in general and India in particular. This move by Fed offers the policy makers in our country some more time to adjust and address domestic economic problems which were also accompanied by capital outflows. No doubt, the Fed may have to take the decision to scale down the bond buying programme sooner or later, but the dovish tone by the Fed provides the Government and the RBI some breathing space. This obviates the urgency to address all problems at one go. The announcement by Fed will help India to tackle the BoP crisis, inflation etc.
The equity market viewed these as a positive measure and this move by Fed may give some sort of guidance to the RBI when it plans to review the mid-term monetary policy tomorrow. There is a chance that RBI may reverse partly, the monetary tightening measures it took during the second week of July 2013 and afterwards to address the currency crisis. The moves that RBI may take tomorrow are expected to aid growth which is a welcome feature for the markets. - V. Balasubramanian Fund Manager – Equity and Gold Statutory
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