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US Fed decision impacts markets

Date: 08 January 2022 Tags: World Economy

Issue

The release of minutes of Federal Reserve meeting has triggered a panic among markets across the world.

 

Background

Indian share markets BSE Sensex and NSE Nifty witnessed a slump after four continuous days of gain.

 

Details

  • The minutes of Federal Reserve meeting indicated that the American central bank might be contemplating to raise interest rates at a faster rate to counter runaway inflation.

  • The Central Bank believes that the domestic American job market is robust enough to handle raise in interest rates. There are plans to hike interest rates three times next year.

  • This re-imposes belief that the Reserve is thinking of rolling back the financial stimulus that had till now feeding stock market gains across geographies.

 

The American situation

  • Many policy makers in US believe that the inflation was diffusing into more areas of the economy and would stay on for a much more time.

  • The Fed wants to taper off the bond purchases that inject money into the financial system by hiking interest steeply in a short period.

  • The US economy is facing one of highest inflations in the history. There is a threat to growth as runaway prices may wreck havoc.

 

Indications

  • The move is seen as a reversal of the central bank’s expansionary monetary policy. It will curtail bond buying programme and bring down long-term interest rates.

  • The faster close-down of the bond-buying programme also means that interest rate hikes in the US are likely earlier than expected.

 

Concerns

The high inflation will force the Fed to taper $30 billion a month of bonds instead of the $15 billion pace that it had announced earlier.

 

Bond buying

  • Bond buying, also known as quantitative easing is an extraordinary measure to help the financial markets and the economy, counter the impact of the pandemic.

  • The bond buying is a monetary policy tool using which the central bank purchases longer-term securities from the open market in order to increase the money supply and incentivize lending and investment.

 

Implications on India

  • Raising Fed Rates would reduce difference between the interest rates of the two countries, making countries such as India less attractive for the currency carry trade.

  • Higher returns in the US debt markets could impact emerging markets, reducing foreign investor enthusiasm.