InvestorQ : With another Federal Reserve meeting coming up towards the end of this month, can you tell me how the Fed policy impacts Indian economy and markets?
swati Bakhda made post

With another Federal Reserve meeting coming up towards the end of this month, can you tell me how the Fed policy impacts Indian economy and markets?

Answer
user profile image
Dia Deshpande answered.
11 months ago


Fed policy normally signals 3 things viz. performance of the US economy, direction and trajectory of interest rates and liquidity situation in the United States. Fed policy is also an important gauge of the direction of the US dollar and therefore of other currencies too. Here is why Fed policy matters to the Indian economy and the markets.

· The Fed outlook sets the tone for the US economy. Normally, the Fed adopts a dovish outlook of lower rates when the growth is stagnating and needs a stimulus. That is the way the Indian markets normally interpret signals. On the other hand, a rise in the interest rates is interpreted as a signal that the US economy is doing well and consumer spending is rising.

· Secondly, the Fed sets the direction for rates in the US but that impacts the trajectory across the world. Since 2008, the longest liquidity driven rally led to most of the major economies in the world synchronizing their monetary stance with the US.

· Fed action is an indicative of which way the FII action will swing. When Fed cuts rates, the yield premium on Indian paper goes up and that attracts more foreign funds into Indian debt. On the other hand if the rates in the US are going up and the dollar is hardening, it leads to risk-off flows to the US and out of EMs. That is when the RBI is also impelled to raise rates to maintain the yield spreads.

· The Fed rate action has important implications for the dollar value and that indirectly impacts the rupee movement in a big way. A hawkish rate policy by the US makes the dollar strong while a dovish policy makes the dollar weaker. The dollar value not only impacts the trade deficit that India runs but also the colour of the flows that come into India.

· Fed also gives important signals on global liquidity. Back in 2013 when the Fed decided to stop the fresh purchase of bonds to put a limit on its balance sheet size at $4.6 trillion, the entire world feared a liquidity crunch and went into a bearish mode.