The US Federal Reserve started Quantitative Easing (QE), which essentially means creating new electronic money by buying bonds from the market, in response to the global financial crisis in 2007-08. Additional money was pumped into the economy to save financial institutions and also the US economy from plunging into a recession.
The 'tapering' or withdrawal of QE first hit the market in 2013 when the then Fed Chairman Ben Bernanke talked about reducing the QE bond-buying scheme to normalise monetary policy operations in the world's largest economy. This sudden announcement of 'tapering' by Bernanke resulted in a huge outflow of dollar money from emerging markets like India, thereby impacting both the stock markets as well as currency value against the US dollar.
The QE measures over the years have swelled the Federal Reserve balance sheet from less than a trillion dollars in 2007 to over $8 trillion now. The sudden 'tapering' by the US Fed is now once again feared as the central bank has been pumping in money into the economy post the pandemic. Let's understand all the connected issues.
What is the current position of Fed rates and bond buying?
The US Fed rate or the short-term interest rates are in a range of 0-0.25 per cent since March last year, which is the lowest or near zero. The Fed rate is the rate at which banks borrow money from the central bank. Just like RBI's repo rate, the Fed rate is the benchmark rate that impacts the lending rates for housing, car, and other loans.
In addition, the Fed is currently buying $120 billion worth of bonds per month from banks and financial institutions. This buying of bonds from the market releases additional money into the financial system. The ultra-low interest rates and bond-buying encourage the flow of cheap money into emerging markets for short-term gains.
Why is the two days Federal Open Market Committee (FOMC) meeting on September 21-22 important?
The 12-member FOMC members set the Fed rates and also manage the monetary policy with the objective of supporting long-term growth and employment. In India, there is RBI's monetary policy committee with half a dozen members, which sets the interest rates in the country. FOMC members are meeting on September 21-22 to take a call on short-term interest rates and a bond-buying scheme.
What are the issues before the FOMC?
The Fed is likely to keep the status quo on short-term interest rates. In fact, the Fed had earlier communicated that the first hike in interest rates is expected sometime in 2022. It could deliberate on further advancing the dates depending upon the discussion amongst the members. The big issue before the FOMC, however, is the pace of slowing down of monthly purchases of $120 billion of bonds. The market is expecting Fed to taper or slow down the monthly bond buying.
What would happen when FOMC decides to slow down its purchase
Any decision to slow down the pace of bond buying will have an impact on the emerging markets. Easy monetary policy with low-interest rates -- both in domestic and global markets -- has fuelled asset prices everywhere. The inflation danger is already rearing its head. There are some economies like Brazil and Russia that have started increasing their interest rates. In India too the RBI has projected an inflation target of 5.7 per cent, which is closer to RBI's targeted upper band of 6 per cent.
Any withdrawal of bond buying would indicate the beginning of the end of the easy money policy cycle globally. This will have an impact on the country's stock market and the rupee value against the US dollar. If the FOMC decides on a very orderly withdrawal or a timeline over a longer period of time, the impact is likely to be lesser.
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