YELLEN SHOWS SHE IS INDEED IN CHARGE!
By Ruma Dubey
The first meet of new Federal Reserve Chairwoman, Janet Yellen and she did make some bold moves. First and foremost, from India and emerging markets perspective, the taper continues and it has been reduced further by $10 billion , bringing in down to a monthly $55 billion. The Fed, on Dec. 18 announced its first reduction in bond purchases, to $75 billion from $85 billion, then followed up with an equal cut in January to $65 billion and now we have another $10 billion cut. Though this was very much on the expected lines, it might not go down too well for the Indian markets when they open for trading today. The initial reaction will be that of disappointment.
Also what has changed for America is that instead of linking the interest rates to unemployment, Yellen has linked it to a wide range of data in determining when to raise its benchmark interest rate from the present zero per cent. This means rates are no longer tied down to the 6.5% threshold of unemployment rate. This too was a widely expected move as linkage to the unemployment data had become obsolete with the rate already at 6.7%.
A quick run through the highlights of the FOMC announcements:
- Reduced the monthly pace of bond purchases or taper of QE by $10 billion, to $55 billion.
- The FOMC repeated that it will reduce asset purchases “in further measured steps at future meetings.”
- End of the taper later this year does not necessarily lead right into raising rates.
- Interest rate hike linked to wide range of data and no longer to 6.5% unemployment threshold.
- Rate hike will depend on assessment of progress towards its goals of maximum employment and 2% inflation ; will also take into account market conditions.
- The view on the current economy was as expected, affected due to winter. The Fed stated, “growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions.”
- Projections for the US economy - the economy will grow between 2.8% and 3% this year, compared to the prediction of 2.8% to 3.2% made in December. Growth in 2015 is seen between 3% and 3.2%.
- Expected to see 1% federal funds rate by the end of 2015 and a target closer to 2.5% by the end of 2016.
Yellen has showed in her first Fed meet that she is indeed a woman in charge and knows exactly what she is doing and what is best for the economy. Clearly, the aim of the Fed will be to provide support as long as necessary and the ultimate aim, like her predecessor Ben Bernanke, would be to return the policy to normalcy over a period of time, without stoking inflation or causing financial instability. She is indeed playing a tough balancing act, taking care of the US economy while ensuring that the rest of the world does not plunge into chaos. Thus this $10 billion tapering can be expected at the next meet too as the easing is happening, slowly and gradually.
But the most pertinent take away from this meet is that as we look ahead at every FOMC, we should brace ourselves for more gradual tapering. Yes, tapering will continue and henceforth it would take a serious US weakness or a major meltdown of emerging markets to make the Fed pause. We probably need to factor in the fact that by the end of this year, the Fed could end the bond purchases and this does mean some weakness in the emerging market currencies.
Rupee could witness some downward pressure and RBI’s Task just seems to have got tougher as Mr.Rajan will now have to field inflation and rupee when he announces the policy on 1st April. So what happens to the Indian markets post this news? Well, to a large extent the markets have discounted tapering but this is likely to cause some strong ripples. Let’s brace ourselves for a rough ride but soon enough, the dust is sure to settle. Also remember, this tapering indicates that the US economy is slowly but surely getting better and we, along with other emerging markets could benefit from exports to US – that’s a better way to grow rather than depend on the largesse of stimulus.