What does the Fed meeting signal for India’s bond market, rupee

Lokeshwarri SK | | Updated on: Sep 17, 2020

The Federal Reserve once again went to great lengths to explain the debilitating impact of the pandemic on the economy in its September FOMC meeting. But the markets can take comfort from the forward guidance provided by the Fed, which assuages market fears about monetary tightening, anytime in the near future.

The Federal Reserve Open Market Committee decided to maintain the federal funds rate in the range of 0 to 1/4 percent and has assured that these rates would be retained as long as maximum employment is not achieved and inflation stays below 2 per cent.

Low rates until 2023

What will be of particular interest to financial markets – both bond as well as forex – is the forward guidance given by the Fed. Federal Reserve Board members and Federal Reserve Bank President project median GDP in the US to de-grow -6.5 per cent in 2020. However, on the lower base, growth is expected to improve to 5 per cent in 2021 before moderating to 3.5 per cent in 2022.

While the projection for growth is not too bad, unemployment rate projection is not as rosy. It is projected at 9.3 per cent in 2020, moving down to 6.5 per cent and 5.5 per cent in 2021 and 2022, respectively.

What is more worrying is that inflation in the US is expected to be at 0.8 per cent in 2020, reflecting lower demand. The Fed is projecting inflation to rise above its comfort level of 2 per cent only in 2023.

With unemployment expected to be quite high and inflation very weak, Fed is projecting rates to stay close to 0.1 per cent until the end of 2022.

The Fed has also stated that it will continue its purchases of treasury securities and agency mortgage-backed securities, at least at the current pace, to maintain credit flow to the economy.

Implications for India

The Fed’s resolve to continue its asset purchases is likely to keep the dollar weak. The dollar index, which tracks the movement of dollar against some of the important currencies, declined slightly after the meeting. While the weakness in euro and the relative resilience of the US economy is supporting the dollar as of now, a weak dollar is likely to keep the outlook for the Indian rupee strong. The rupee has already strengthened 5 per cent since March. This strength will continue if the Fed continues to print money.

Low interest rates in the US until 2023 has repercussion for Indian bond market. Higher yield of Indian 10-year bonds, currently at 6 per cent, should make these attractive to foreign portfolio investors. But that is not happening because of inflation in India, ruling above 6 per cent, making real bond yields negative. FPIs have net sold $110,631 crore of Indian debt so far this year. Besides the RBI’s rate cuts, the combined borrowing of the Centre and States of more than ₹20-lakh crore for FY21 and the high inflation are rendering Indian bonds unattractive.

While recovery is the US economy by 2021 is good for Indian merchandise and service exporters, the Fed’s prognosis on the need for economic stimulus until 2023 means it will be some time before all is well for financial markets.

Published on September 17, 2020
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