Global markets, in a tizzy for weeks over the possible unwinding of bond purchases which would push up borrowing costs all over, had been waiting for clarity from the Fed of its intentions on its bond purchases to support US growth. The Fed announcement on June 19, which has significant implications for domestic economy and for the rest of the world, came as a dampener for investors.

US stocks plunged and the Dow Jones industrial average fell by 200 points at the close of the day. The market reaction became sharper after Fed Chairman Ben Bernanke told a press conference that the unwinding process could begin later in this year, if there is further improvement in economic conditions. Fed noted growth is already on a moderate pace with a strong revival in housing market.

The majority view in the Federal Open Market Committee (FOMC), which sets the policy stance, according to the Chairman, was that the process of asset purchases could begin later in the year and ended by mid-2014 if economic trends are in line with the Fed Outlook Projections.

At the same time, Mr Bernanke made it clear that the short-term interest rate, lowered rapidly with the eruption of the global financial crisis in 2008, to near zero, would be kept unchanged till the unemployment rate comes down to 6.5 per cent from the present 7.6 per cent.

According to the forecast released by the Fed on June 19, unemployment rate would decline more quickly than had been previously anticipated. It would fall to 6.5 to 6.8 per cent by the end of 2014. If these projections are correct, a rate increase could come in the first quarter of 2015.

Mr Bernanke said “our policies (pull back of purchases or interest rates) would be adjusted according to change in economic conditions. Fed would provide information on unwinding of its purchases “at the appropriate time”. The Fed’s loose monetary policy was designed to help economy recover from the recessionary effects and promote job creation.

The FOMC statement at the end of its two-day meeting on June 19 said for making continued progress toward maximum employment and price stability – the twin mandated objectives of the independent Federal Reserve – “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens”.

Mr Bernanke said a change in the Federal Funds rate was “far in the future” and there would be considerable time between the end of quantitative easing and setting rate hikes. The exceptionally low - zero to a quarter percent would be appropriate “at least as long as the unemployment rate remains above 6.5%”.

Inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2% longer-run goal, and “longer-term inflation expectations continue to be well anchored”, according to the statement. Fed policy tools are being employed as appropriate until the outlook for the labour market has improved “substantially in a context of price stability”.

While the Committee statement did not specify a road map for the withdrawal of quantitative easing, the strategy under consideration was unfolded by Mr Bernanke in his press briefing. He said the Fed planned to continue asset purchases until the unemployment rate fell to about 7 per cent, which could be by middle of 2014.

Fed would be closely monitoring incoming information on economic and financial developments in coming months and would be prepared “to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives”, it said.

The Fed said economic activity has been expanding at a moderate pace and labour market conditions have shown further improvement in recent months though the unemployment rate remains elevated. Household spending and business fixed investment advanced and the housing sector has strengthened further. But Fed entered a caveat on fiscal policy saying it was “restraining economic growth”. This is in line with IMF assessment that “excessively rapid and ill-designed fiscal deficit reduction” was being followed instead of a more modest and gradual pace of fiscal consolidation.

Financial analysts in Washington speculated as to whether an improved outlook projection by the Fed was designed to accelerate the momentum toward reducing the pace of asset purchases in the coming months prior to rate revisions. Fed officials say only after a considerable interval after bond buying comes to an end, the interest rates could begin to rise, all depending on economic conditions emerging according to current forecasts. It would have to be at least until the unemployment rate falls below 6.5 per cent.

In providing the clearest indication of Fed intentions at his press conference, Mr Bernanke said he expected the jobless rate to be 7 per cent when purchases stopped by the middle of 2014. The plans could change if there is loss of momentum in economic recovery, he added.

In any case, it is obvious once the latest QE of Fed, which has increased the Fed balance-sheet to 3.3 trillion, is withdrawn, global interest rates would become higher and it would raise costs of borrowing for all countries. Countries like India which hopes with some ambition and easier capital flows to get back to pre-crisis growth rate average of 8 per cent within two to three years from 5 per cent in 2012/13 would be hit hard, in particular. (IPA Service)