THE US FED TIPTOES ON TAPER - $10 BILLION/MONTH EASING

By Ruma Dubey

All indications were there, stark and clear as a bright day in the sun; that the Fed would announce tapering on its bond buying program at the FOMC meet tonight. And finally the inevitable has happened and the tapering, albeit gradual, has been put in place.

A quick read through the tapering:

• Fed tapers QE to $75 billion monthly pace from the current $85billion
• It is pulling back on its purchases of mortgage-backed securities and Treasury’s by $5 billion each.
• Tapering will start in January
• The Fed has made it amply clear – it is tapering and not tightening
• Fed is likely to reduce the program at future meetings in “measured steps.” But the FOMC reiterated - purchases are “not on a preset course.”
• Future bond purchase adjustments deliberate, data dependent – if economy slows, one or two monthly tapering could be skipped and if it improves, the pace could be hiked.
• Low inflation remains a big cause for concern.  It has not breached 2% since March 2012.

When the Fed had talked earlier about easing and keeping interest rates at near zero, it had issued certain conditionality’s - unemployment exceeds 6.5% and outlook for inflation is no higher than 2.5%. Well, the data released last month indicated that unemployment was at a five year low of 7% but inflation was well below Fed’s target at a mere 0.7%.  

Two different continents, two governors but both dealing with the same issue – inflation. In India, the problem is of very high inflation which is why Raghuram Rajan maintained a status quo on rates yesterday. On the other hand, in USA, Bernanke has too low inflation; he wants prices to start rising but thankfully, he did not allow inflation alone to decide on the tapering. Just as our Governor reiterated time and again that future action was data dependent, Bernanke mouthed exactly the same words, saying all future action was “data dependent.”

Addressing his last press conference, Ben S. Bernanke, chairman of the Federal Reserve, due to retire by on 31^st Jan’14,  started the process of ending what he had started.  The Fed has purchased more than $1 trillion in Treasuries and mortgage bonds during 2013 in an effort to encourage job creation. The Fed said the move was made “in light of cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.” More reductions are expected “in measured steps” at future meetings. But the moot question here – will the economy move in tandem with the Fed’s estimations?

What was also pertinent about the FOMC meet tonight was that the Fed issued economic estimations for the next year. Setting this policy today, is actually how the Fed perceives the economy to pan out over the next few years. And as the forecast starts getting stronger, lesser will the crutch of Fed be required.  The Fed is sticking to the forecast for 2014 that it laid out in September. It see’s growth in GDP  next year between 2.8% and 3.2%, unemployment rates falling to between 6.3% and 6.6% and inflation as measured by the personal consumption expenditure price index between 1.4% and 1.6%.

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 ripples, yet it will not fall off the cliff as the tapering amount is nominal. The markets may not react as much as they did last time when the US Fed had first announced tapering.  The market should remember that 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.