Fed Goes Ahead With ‘Operation Twist’, Holds QE III

The much-awaited event of the Fed’s Open Market Committee (FOMC) meeting took place yesterday with the Fed again taking a pause on the third round of quantitative easing (QE) which to some extent disappointed investors on Wall Street. The impact was immediately felt across the globe, evident from the fact that the other Asian markets closed today in the negative territory while there were some signs of nervousness on D-Street too in the initial trades.

As per the street expectations, the Fed had broadly three options i.e. to go for liquidity easing, conduct an ‘operation twist’ or to some extent go for both the options. The Fed chairman selected ‘operation twist’ and gave the others a pause. Investors therefore need to understand what is ‘operation twist’ and its impact on the economy. In simple terms, Fed will sell the short-term treasury bonds and buy long-term bonds of the same amount from the market. This in turn will help the long-term interest rate to remain at the low level.

The low interest rate will further fuel growth in the economy and will result into higher spending. According to media reports, the existing operation twist was about to expire in June 2012 and hence the Fed extended that operation. For the rest of 2012 short-term bonds of approximately USD 267 billion will be sold and then bought for a longer duration. Another key announcement which the Fed’s chairman made was that the growth outlook for 2012 would be anywhere in the range of 1.9 and 2.4 per cent against the earlier forecasted range of around 2.4 to 2.9 per cent.

The unemployment rate for the year-end is expected to be around 8 to 8.2 per cent higher than the previous estimate of around 7.8 to 8 per cent. Hence, the Fed has revised the growth outlook downwards and the unemployment rate upwards which further indicates that the U.S. economy is struggling to grow in the current environment. The policy makers also retained their view (since December 2008) of keeping the interest rate at lower levels in the range of 0 to 0.25 per cent. Therefore, those who had expected some easing from the Fed were disappointed.

Would QE III have been helpful? And has the step taken by the Fed been in the right direction, particularly with respect to Indian economy? We believe that a pause in QE III will help the Indian economy going ahead. First, the easing would have easily helped the commodities’ prices to move northwards, thereby further fuelling inflation in the country. The U.S. is the world’s largest economy and plays a major role when it comes to the demand for crude. With the Fed decision, the Brent crude prices have fallen sharply to around USD 91 per barrel from the level of around USD 125 per barrel in the month of February and March. With around 33 per cent of the import bill derived from crude oil purchase, it will further help our current account deficit to be at a decent level. However to some extent this has been offset by the rupee which has depreciated further and is trading at Rs 56.3 per dollar which is near to its all time low.

Hence the overall outcome of yesterday’s FOMC meet in context to Indian economy could be considered as positive. The issues from the euro region will, however, continue to persist. But there are multiple domestic factors like rupee depreciation, high inflation concerns on the deficit front, a policy-paralysed government, etc that are pinching the Indian economy in a more direct manner.