Ending all speculation about the road ahead for the economic-data dependant conditional taper of its $85-billion-a-month bond buying programme or third round of quantitative easing (QE3), the US Federal Reserve chairman Ben Bernanke decided to await more evidence that (economic) progress will be sustained before adjusting the pace of its purchases.
“Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labour market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy,” Federal Open Market Committee (FOMC) said in a statement.
“However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month FOMC,” it added.
Impact
The move is likely to spark off a ‘risk-on’ sentiment across the emerging markets, especially India that has seen a heavy outflow of investable funds to more lucrative destinations. However, after the initial euphoria settles, analysts expect rise in uncertainty and volatility going forward.
“Questions will also arise about using an unemployment rate of 7.0% as a benchmark for ending QE3. The unemployment rate fell to 7.3% in August, so if tapering does not start earlier than December, the Fed may have to taper rather aggressively once it has started if unemployment continues to fall,” said Jan Lambregts, managing director and global head of financial markets research, Rabobank International.
“The FOMC missed several opportunities to manage market expectations about the first taper. Hence the strong market reaction to today’s decision. While Bernanke said that the FOMC does not let market expectations dictate its decisions, the Committee has not done a very good job in managing those expectations. This means a rise in uncertainty and volatility going forward,” he added.
RBI’s policy review
Now that there is some clarity on the road ahead for the tapering plan, all eyes will now be on RBI Governor, Raghuram Rajan when the Reserve Bank of India (RBI) reviews the Monetary Policy on Friday that will provide a first glimpse on the new governor’s approach to tackling the country's growth-inflation dynamics and external vulnerabilities.
Market expectations range from a partial reversal of liquidity-tightening measures at one extreme to a repo rate hike to contain inflation risks at the other.
“A complete reversal of liquidity-tightening measures on 20 September looks unlikely to us. While the rupee's appreciation is encouraging, the RBI might prefer to wait longer for confirmation of sustained currency stability – a factor that has been emphasised as a key determinant of such a reversal,” Anubhuti Sahay, Nagaraj Kulkarni and Priyanka Kishore, analysts with Standard Chartered said in a note.
“However, in order to reassure the market that these measures are temporary, the RBI might recalibrate some of its announcements. For example, it could reduce the daily minimum cash reserve ratio (CRR) balance from 99%, or marginally increase the liquidity adjustment facility (LAF) borrowing limit from 0.5% of net demand and time liabilities (NDTLs). These changes are unlikely to reduce the call rate substantially below the marginal standing facility (MSF) rate (currently 10.25%); but we believe they would offer some comfort to the markets, with the hope of further easing later,” they added.
by
Shah Mohammad Abdul Qadir
PGDM-I
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