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Is the Fed confused over the future policy action?
Fri, 21 Mar Pre-Open

The US Federal reserve in its recent policy meeting once again cut its monthly bond purchases from US $65 bn to US $55 bn. Fed Chaiman Janet Yellen stressed that with the job market still weak, the Fed intends to keep short-term rates near zero for a considerable time and would raise them only gradually. And she said the Fed wouldn't be dictated solely by the unemployment rate, which she feels no longer fully captures the job market's health.

But Yellen might have confused investors when she went further, suggesting that the Fed could start raising short-term rates six months after it halts its monthly bond purchases, which most economists expect by year's end. That would mean short-term rates could rise by mid-2015. A short-term rate increase would elevate borrowing costs and could hurt stock prices.

The mixed message raises concerns of another Fed communication failure. Last year, the Fed had a tough time persuading investors it could gradually reverse quantitative easing without accelerating its first rate increase.

If investors once again start to doubt the central bank's commitment to allow inflation to reach 2% before it raises rates, there will be a fresh bout of fund-raising pain for countries like Brazil, India and Indonesia whose current accounts are in deficit. Heightened uncertainty about the timing of US rate increases could also make global markets more volatile, further slowing down investment.

The impact of this will be felt by Indian stock markets as well. What is more, massive FII outflows could have an impact on the rupee at a time when India's fiscal and current account deficit (CAD) positions are precarious. But this is only one aspect which could have a negative bearing on the markets. This is because it has its own demons in the form of slow economic growth, consumer price inflation and fiscal deficit to deal with.

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