Glance of the FED Statement and What it Means for India

On 15-December, the US Fed put out a detailed statement on the trajectory of its monetary policy. Here are the major takeaways from the Fed statement and what it means for Indian markets in general and Indian monetary policy in particular.

Fed says, rate hikes sooner rather than later

1) In US Fed parlance, taper refers to the speed at which the balance sheet is wound down. What was to end in June, will now end in March itself. In short, the Fed has enhanced the cut in monthly bond buying from $15 billion to $30 billion from Jan-22. That means two things; liquidity will vanish faster and rates will go up sooner.

2) The Fed policy has been largely focused on bringing down inflation to reasonable levels. For November 2021, the US Inflation was at 6.8%, a level last seen in the year 1982. As a result, inflation now takes center stage for the Fed and economic growth revival and the Omicron risk have got just a passing reference.
 

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3) Inflation is clearly the driving factor for the aggression shown by Fed in ending the bond buying program and in front-ending rate hikes. But the other issue is asset valuations. Powell underlined that a hawkish monetary policy was the key to prevent a speculative bubble from becoming a systemic risk across markets.

4) For a long time, the Fed used the word Transitory to describe inflation. That means, high inflation would vanish as fast it came. That is not the argument any longer. Now Powell talks about elevated inflation because despite the best efforts of the Fed and the US government, they are just not able to get a handle of inflation. It is not going away soon. 

5) Powell has made two very significant points in the Fed statement. Firstly, he admitted that high inflation forced the Fed to wrap up the bond buying program in Mar-22 instead of Jun-22. Secondly, he did not feel that Fed would wait too long after March to start rate hikes. That could mean 2-3 rate hikes by July 2022 itself.

6) What about jobs. The Fed has also crystallized its though process on this subject. Powell has admitted that labour recovery had not been as impressive as the economic recovery. However, considering the technology impact on jobs, Fed will be satisfied with improvement in labour participation and not insist on return to labour normalcy.

7) To sum it up, the Fed does not want to test the patience of the markets any longer. They want to front-end the taper and also the rate hikes. It may cause disruption in the short term but the Fed is willing to live with that rather than risking long term damage to the economy and the monetary system.

Does this Fed statement create risks for Indian economy?

Unfortunately, the statement not only creates risks but is also an urgent call to action.

A) India has long been debating whether the US would actually go the whole hog on liquidity tightening and rates. That is not a debate any longer. Rate hikes are just round the corner and now India needs a Plan-B to handle the flow risks that come with such an aggressive rate hike decision. 

B) The way the Nifty and Sensex have rallied in the last 20 months, speculative bubble is as much a reality in India, as it is in the US or any other country. RBI may have to move really fast on shifting out of its accommodative monetary stance and also put out a timetable for rate hikes to check portfolio outflows.

In the short term, Indian markets are likely to see a surge in volatility in the equity, debt and currency markets. The next few weeks could be a challenging time for Indian policymakers.

Also Read:-

Highlights of RBI Monetary Policy