The US Fed meeting as well as the Bank of Japan meet on monetary policy concluded on the 21st of September. The key metrics with respect to the US Fed was whether the Fed would hike rates and its trajectory on future rates. The key metrics with respect to the Bank of Japan was would it dip interest rates further into the negative zone. While both the central banks maintained status quo on rates along expected lines, there were some interesting takeaways from both the policy statements.
For the US Fed, it was all about trajectory
Even before the September Fed meet commenced on 20th September, the general consensus was already that the US Fed would maintain status quo on rates. The US Fed had hiked rates by 25 basis points in December 2015 after a gap of almost 9 years. Post the December hike there a few key factors that pre-empted further rate hikes. Firstly, the global markets lost nearly $12 trillion in market value in the aftermath of the rate hike in December 2015 and the US was keen to avoid a repeat of that. Secondly, BREXIT came as a surprise and the US Fed was keen to ensure that the rate hike does not worsen volatility in an already stressed global macroeconomic scenario. Thirdly, the Fed was always worried about monetary divergence. With other large economies like the UK, EU, Japan and China adopting loose monetary policies, any rate hike by the US would have created tremendous volatility in financial markets as yields and currencies adjusted themselves. This was a situation that the US wanted to avoid.
The US finally has a favourable set of data points that may partially justify a rate hike. Although, inflation has been low due to weak oil prices, expected inflation is getting closer to the 2% mark. Despite slow growth in business spending and investment, there has been a sharp spurt in household spending and retail consumption. Despite the fact that the wage growth has been slow, the labour force is as close to full employment (at 4.8% unemployment) as is feasible. All these factors have created a situation where the US Fed can seriously consider a rate hike in the foreseeable future. In terms of visibility, it is doubtful if the Fed would hike rates in its next meeting in early November as the US presidential elections would not be completed by then. However, it is highly likely that the Fed may hike rates by 25 basis points in the December meet. Broadly, the rate trajectory of the US Fed will be calibrated upwards but the final level will be much lower than originally anticipated. The cautious hawkishness of Janet Yellen’s speech points towards a calibrated hike in Fed rates which will be more back-ended and on a lower trajectory.
Bank of Japan policy was more about liquidity
The Bank of Japan in its monetary policy kept rates static at -0.1%. There was a general expectation that the BOJ may tilt the rates further into negative territory. However, the BOJ statement was significant in more ways than one. Firstly, the BOJ has reinforced that it will maintain the yield on 10-year Japanese Bonds at above the Zero level, notwithstanding the level at which rates are set. This is a clear indication that the BOJ is shifting its strategy from giving rate signals to managing yields through liquidity management. Japan has refrained from cutting rates further into negative territory as the outcome of its loose monetary policy has not been too flattering.
Abenomics, as the strategy is popularly known, worked in the initial years but over time its efficacy has waned. Negative rates did not lead to higher lending by banks to industry. On the contrary it only helped fuel asset price bubbles. The latest BOJ policy is a clear indication that the BOJ is not willing to let yields slip further even if rates need to be cut. In a nutshell, the BOJ may be indicating the bottoming out of rates cycle in Japan.
What are the key takeaways for India and other EMs from the Fed and BOJ?
There are 4 key takeaways for EMs in general and India in particular from a combination of the signals from the Fed and the BOJ:
- Liquidity in the financial system is unlikely to go away in a hurry. Irrespective of the direction of rates, most central banks are likely to keep liquidity abundant. That is good news for markets like India where capital flows are the core.
- The incremental benefits from rate cuts may be waning for most of the large economies. We may be nearing a bottoming out of interest rates across the world.
- The US dollar is likely to strengthen but a strong Yen will keep the dollar appreciation in check. That is good news for India with its $22 billion FCNR payout this year.
- With yields on the lower side and money remaining abundant, global capital will still be in search of alpha. India with its combination of above 7% GDP growth, attractive returns on investments and a stable rupee will be at an advantage.