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US Fed defers policy easing

Global financial markets rallied to new highs on September 18, with investors surprised by the Federal Reserve’s decision to defer a widely expected unwinding of its monetary stimulus, which was set to begin in September/October, until it could see stronger data on US economic recovery and jobs. The Fed will continue with its current assets purchase programme totalling 85 billion dollars a month which, by keeping market interest rates low, provides support to the broader economy.

Emerging nations including India which are in deficits were concerned over capital flights and currency depreciation as a fall-out of the US unconventional monetary accommodation (Quantitative Easing). But the Fed Chairman Ben Bernanke has always maintained that the policy, though designed directly to benefit US economy, would also be good for other countries looking for external demand, and for global growth.

The Fed’s sudden turnaround, when global markets were braced for a taper, was influenced by several factors including the potential impact of the gridlock in Congress on spending bills and threat to oppose raising of debt ceiling by Republicans. Soon after the announcement, US markets were on a steady climb and Dow and S and P stock indices were at record highs. Interest rates also fell and the yield on the benchmark ten-year Treasury  securities reversed its recent gains. But among analysts there was some apprehension that Fed’s volte-face might store up confusion for the future. This is notwithstanding a clearer communication by Fed of its policy intentions and forward guidance. In its statement, the Federal Reserve cited insufficient progress in US recovery and also pointed out that the fiscal policy (sequester) is already ‘restraining economic growth’.

Speaking at a press conference at the end of the two-day meeting of the Federal Market Open Committee (FOMC), Bernanke said the coming fiscal debate in Congress would have ‘additional risks’ for the economy and any failure to raise the US debt ceiling would have ‘serious consequences’. The Fed Committee has concerns over rapid tightening of financial conditions in recent months which could have the effect of slowing growth, it was noted.
The Committee’s concern would be exacerbated if conditions tightened further. Finally, the extent of the effects of restrictive fiscal policies remains unclear for them and Chairman Bernanke feels upcoming fiscal debates may involve additional risks to financial markets and to the broader economy. The fiscal standoff between the Obama Administration and the House Republican majority over the budget and debt ceiling revision is already reaching a climax.  Budget wars have become an annual feature in Washington and this time, the Republicans are insisting on more spending cuts to debunk the President’s signature Healthcare reform.  Any such bill would be rejected by the Senate Democrats and would have no chance of reaching the President’s table.  If there is no bipartisan deal on the budget, there will be a Federal shutdown on 1 October, when the new fiscal year begins.
In its review of economic conditions, FOMC said the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. The rise in mortgage rates was also a risk for the housing market which had been recovering in recent months. Also, inflation persistently below its 2 percent objective could pose risks to economic performance.
Contrary to earlier firm indications of the process of unwinding ‘late in the year’,  Bernanke now said there was no fixed calendar for it.  FOMC’s decisions in this regard in coming months would be ‘contingent on the economic outlook and its assessment of the efficacy and costs of such purchases’. Economic data at present did not warrant reducing asset purchases while the unemployment rate (7.3 per cent) also remained ‘above acceptable levels’, the Fed Chairman pointed out.

In this background, Fed has revised down its own GDP projections to a range of 2.0 to 2.3 per cent in 2013 and 2.9 to 3.1 per cent.  FOMC expects, with appropriate policy accommodation, economic growth would pick up from its recent pace and jobless rate would gradually decline toward levels which are consistent with Fed mandate of fostering maximum employment and price stability. The Fed has decided to wait for more evidence for sustained progress before it could begin ‘adjusting the pace of its purchases.’

The Fed statement seeks to present a clearer communication of its monetary policy accommodation, conventional or otherwise. Taken together, it says, its actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. This in turn would promote ‘a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate’.

Bernanke said along with the  purchases of Treasury and agency mortgage-backed securities, the Fed would continue employing other policy tools as appropriate, ‘until the outlook for the labor market has improved substantially in a context of price stability.’ 

According to the statement, if the revised projections become valid, the asset programme could be completed possibly by the middle of 2014. The near zero key interest rate would continue beyond the completion of the asset purchase programme for a ‘considerable time’.  
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