Fed Policy – As growth returns to the US, what happens to Fed rates?

fed Fed Policy   As growth returns to the US, what happens to Fed rates?

Two key events in the US economy could have larger implications in the days to come. The Fed statement clearly ruled out any rate hikes or tightening in the near future. At the same time, US GDP growth touched an 18-year high of 6.4% in the Mar-21 quarter?

Fed categorical about status quo

Perhaps the only shift in the Fed policy statement during the previous week was that it acknowledged that inflation and GDP growth were back to above pre-COVID levels. However, the statement also underlined that it did not see any reason to hike the Fed rates in the near future unless growth and inflation were of a sustainable nature. Through 2021 and 2022, the Fed has virtually ruled out any chances of either a rate hike or even a halt to its bond-buying program.

What does the Fed Watch say?

It is said that in between the diverse views of analysts and economists, the market rarely deceives. Bond yields are up indicating that inflation could actually harden going ahead. However, if you look at the Fed Watch tool capturing the Fed futures implied probabilities, then there does not appear to be more than a 14% probability of rate hike even till the Dec-21 FOMC policy meet. That means; even if growth and inflation shoot up, the Fed may, at best, adopt a calibrated approach by first tightening liquidity before really raising Fed rates.

How real are the macros?

The Fed has repeatedly harped on the word sustained inflation and sustained growth to underline the reason to hold rates. Firstly, the Fed feels that inflation is largely a supply-side phenomenon in the US and across most parts of the world. Hence the inflation could safely be assumed to subside once the supply-side constraints are dealt with. On the growth front, the Fed has pointed out that the growth recovery was uneven and driven by helicopter money. Hence any reaction to the spike in growth would be based on sustainability. With GDP growth at 6.4% and inflation at 2.5%, Fed may be racing against time.

What this means for India?

One thing is clear that the RBI or the government is unlikely to permit too much monetary divergence from the US monetary policy. The latest Fed policy gives the much-needed comfort. It is not like inflation and growth are not a challenge. Both, in India and the US, remain huge macro challenges for the central banks. However, the Fed statement ratifies the RBI stance that rates should be held low and liquidity comfortable till the time sustainable growth returns and sustainable inflation actually threatens the economy. Above all, it also means that liquidity flows into the financial markets will continue. For now, that could be the biggest takeaway from the Fed statement for India!

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