Everything you need to know about the latest Fed meeting

What are the expectations?

The US central bank is likely to tighten monetary policy for the first time since reducing borrowing costs to nearly zero in 2020 to counter the economic impact of the pandemic. Fed funds futures, which track short-term rate expectations, have seen a total of four rate hikes this year. Economists at Goldman Sachs see a risk that the Fed will tighten monetary policy more aggressively than anticipated. It is also expected to give a final set of instructions to conclude its asset purchase programme. This process began last November, and at the current pace, will close in mid-March, at which time the first rate hike may occur.

What has the US Fed done so far?

As the pandemic spread, the US Fed launched a quantitative easing program where it would buy $120 billion worth of bonds every month to ensure adequate liquidity. Inflationary pressures, supply-demand mismatches, and a jobs recovery prompted the Fed to change the deal in the second half of 2021, and the Fed said in November that it would reduce its bond purchases by $15 billion each month. Exactly a month later, this was doubled to $30 billion, speeding up the tapering process. In addition, funds deposited in the Fed’s reverse repo continued to rise, reaching $1.6 trillion in December 2021, indicating a liquidity surplus.

How does the rate decision affect India?

Like other emerging markets, India suffers from rising US bond yields, resulting in capital outflows and pressure on the currency. During the ‘taper tantrum’ of 2013-14, India had to take several steps to support the rupee and stabilize capital flows. India is now in a better position with record forex reserves, inflation within the RBI’s tolerance band and stable currency.

What about fund flow?

Typically, rate hikes in the US lead to outflow of foreign funds from emerging markets, including India. Indian markets have been facing selling pressure since January 18, with both Sensex and Nifty falling over 6% in a week. The continuous sell-off by FIIs so far in January has pulled out $1.26 billion from the Indian stock markets. But domestic institutional investors (DIIs), which include mutual funds, insurance firms, pension funds and banks, are net buyers of shares of value. 7,430.35 crore so far in 2022, mitigating the decline to some extent.

Will the Fed’s move affect other asset classes?

Over the past few weeks, bond yields have risen globally as the Fed’s tough stance to control high inflation prompted investors to prepare for a sharp end to easing monetary policy. The jump in global bond yields pushed up the Indian government’s 10-year bond yield and 10-year AAA-rated corporate bond yield. With equities recovering faster than the Fed expects, analysts at Credit Suisse Wealth Management (India) do not expect Indian equities to de-rate materially in the next few months.