In Focus

Published: Dec 29, 2021
Updated: Dec 29, 2021

US Fed Policy

Asset purchases lift US economy: May impact India inflow

The US Federal Reserve at its latest monetary policy meeting, the fifth in 2021, kept interest rates unchanged near zero and agreed to continue with its monthly asset purchases of $120 bn until substantial further progress is made towards employment and price stability. Even as the Fed retained its accommodative monetary policy stance, it signalled that it stands prepared to adjust its monetary policy stance on persistent price pressures and evolving economic conditions. The policy rates have been left unchanged since midMarch 2020, after they were reduced by 100 bps in an emergency move due to the coronavirus pandemic. Some of the monetary policy announcements are:

Assessment of US economy Economic activity and employment continue to strengthen, supported by the unprecedented fiscal policy, progress in vaccination and the accommodative monetary policy. The Fed expects real GDP this year to post the fastest rate of increase in decades. While much of this improvement is the bounce-back in activity from depressed levels, the sectors most adversely affected by the pandemic have not fully recovered. While business investments have been increasing at a solid pace, in some industries supply constraints are restraining activity. Although conditions in the labour market continue to improve, the rate of employment is yet to see noteworthy gains. The participation rate in the labour market has not moved up from the low rates that prevailed for most of last year. While acknowledging that the impact of the pandemic on the economy has been diminishing, the Fed sees risks to the economic outlook with the slowing in the pace of vaccination and the spread of the ‘Delta’ strain of the coronavirus.

View on inflation The Fed maintains that the rise in price levels is likely to be transitory and that it would ease towards the longer-run goal (of 2%). It expects inflation to remain elevated in the coming months before moderating. The reopening of the US economy and the rebound in spending has resulted in larger-than-anticipated supply bottlenecks, given the inability of some sectors to quickly scale up production.

The Fed warns that although the supply side issues are expected to abate, there is the possibility that inflation could be higher and more persistent than expected. In case it sees signs of persistent longer-term inflation above the goal of 2%, the monetary policy stance would be adjusted.

Asset purchase review In the just-concluded meeting, the Federal Open Market Committee (FOMC), that is responsible for asset purchases, reportedly reviewed some considerations for adjusting its asset purchases (pace and composition) once economic conditions warrant a change. The monthly asset purchases ($ 80 bn of Treasury securities and $ 40 bn of MBS) have been a major policy tool of the Fed for enabling easy financial conditions (to support flow of credit to businesses and households and thereby stimulate economic activity) and the smooth functioning of the markets. As of July 21, 2021, the Fed’s holding of US Treasury securities stood at $ 5.2 trillion and that of MBS at $ 2.4 trillion, a 76% and 75% increase respectively from end-March 2020. With the FOMC members expecting ‘substantial further progress’ in the economy, asset purchases are expected to be scaled back. The Fed will be assessing the economy’s progress based on incoming data in the coming meetings to decide on the tapering of its asset purchases. As such, it did not set a timeline for reducing its asset purchases and stated that advance notice would be provided for making any changes to its asset purchases. Markets’ reaction to policy

The markets have been keenly watching the policy for indication of stimulus tapering. Although the Fed did signal that it is evaluating adjusting its asset purchases, it did not indicate any timelines for the same. Market movement in the US was thus limited, with interest rates to remain low and liquidity to continue in the near to medium terms, even as economic recovery strengthens. The Asian and Indian markets however opened higher, boosted by expectations of continued foreign inflows into their markets. The benchmark 10-year Treasury yields ended the day nearly stable at day-ago levels of 1.23%, following the sharp fall (by 5 bps).

Implications for India According to Care Ratings, although the scaling back of asset purchases by the Fed would have implications on the flow of funds into the Indian markets, given that the timeline and scale of the same has not been specified, it is unlikely to have any significant impact in the near future. In terms of monetary policy action, the RBI’s monetary policy would continue to be driven by domestic considerations of economic growth. Towards this end, it would continue to maintain its accommodative monetary policy despite price pressures