What do US Fed’s minutes indicate and what could RBI do now?

The US Federal Reserve could shrink its $9 trillion balance sheet by as much as $95 billion every month, beginning May, according to the minutes of the last meeting. 

This effectively means that the Fed is looking to end the flow of easy and cheap money twice as fast compared to what it had indicated earlier. 

At the March 15-16 meeting, the Fed approved its first interest rate increase in more than three years. The 25-basis-point rise— a quarter percentage point — lifted the benchmark short-term borrowing rate from the near-zero level where it had been since March 2020. But going forward, the rate hikes could be twice this, at 50 bps.

So, what do the Fed minutes exactly say?

The minutes show that there was considerable sentiment to go higher last month itself, but the prevailing uncertainty over the Russian invasion of Ukraine deterred some officials from going with a higher increase in March.

“Many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified,” the minutes said.

Moreover, the minutes show that the Fed officials “generally agreed” that a maximum of $60 billion in Treasury holdings and $35 billion in mortgage-backed securities would be allowed to roll off, phased in over three months and likely starting in May.

CNBC said in a report that the total would be about double the rate of the last effort, from 2017-19, and represent part of a historic switch from ultra-easy monetary policy.

How did the US stock markets react to the news of the Fed’s aggressive stance?

Expectedly, the markets fell while government bond yields spiked. But the stock market did rebound after a while. 

How will this affect emerging markets like India?

A faster tightening of the belt will see a flight of capital from emerging markets like India. The Indian stock market ended in the red on Wednesday and began Thursday also in the red, down by more than 0.7% in early trade. 

Riskier assets corrected after Fed Governor Lael Brainard said that the central bank would start balance-sheet reduction ‘at a rapid pace’ as soon as next month. Indian market observers say local equities are yet to price in such a prospect.

But is the Fed’s hawkish stance the only thing spooking the stock markets?

Not really. Reports of fresh sanctions against Russia crushed sentiment. Investors were worried that the growing isolation of Russia from international trade would further disrupt commodity flows. The new sanctions include a possible US ban on investment in Russia and the European Union ban on coal imports.

“Weaker global cues led to some weakness in the domestic market, as investor sentiment turned cautious after a more hawkish tone by the Fed. With this development, a sharp movement was seen in the US 10-year bond yields, which crossed 2.6 per cent levels,” a Business Standard report cited Neeraj Chadawar, head-quantitative equity research, Axis Securities, as saying. 

What about firefighting inflation?

Across the world, including in India, central banks are worried about rising inflation. Central banks across the world have prioritised tackling inflation after terming price rise as a transitory phenomenon last year. A combination of supply-side disruptions and geopolitical tensions has led to a rise in commodity prices.

What is the Reserve Bank of India expected to do?

India’s central bank, too, could go in for rate hikes this year but may stand pat at its policy meeting this week. However, it may revise its inflation outlook given that the price index is already above its upper limit of 6% and could rise further after adding the impact of an increase in petrol, diesel and natural gas prices.

“Since the last monetary policy committee meeting, several factors, such as geopolitics, oil and commodity prices, bond yields, and inflation expectations, have altered. Given the rising commodity prices pushing inflation expectation to the higher side, the RBI’s stance remains critical at this juncture,” Chadawar said.