5 reasons why US Fed policy affects you

We are living in a highly globalised world, where the happenings in one part of the globe affect other parts. In this case, we are talking about the effects of the US Federal Reserve on world stock markets.

Indian markets have been choppy in September. After hitting a peak of 27,300 - levels, the BSE Sensex shed nearly around 800 points to 26,500 - levels. However, it gained as much as 480 points on Thursday. This was a reaction to a meeting that took place in America. The Federal Reserve, the US central bank, announced its stand on future interest rates.

Here are things to know about the relation between the Fed's policy and the Indian markets:

Importance of Federal Reserve:

Like the Reserve Bank of India, the US Federal Reserve controls two key market factors - money supply and interest rates. While the actions of RBI are limited to India, any indication of an interest rate change by the US Fed affects the whole world, including India. That is because a large chunk of global money is invested in US government bonds or dollar-denominated assets. America continues to hold interest rates at zero and print more money in exchange of bonds. This is also called quantitative easing. This money finds its way into emerging markets like India and other asset classes like commodities. In 2013, markets received a jolt when the Fed announced a change in the Quantitative Easing (QE) programme. The action was a hint that interest rates could rise in the future. Share prices tumbled and money was moved out of risky assets. Emerging markets like India saw money pulled out largely of the debt market.

Fed announcement:

The Federal Reserve announced on Wednesday a continuation of its zero-rate policy for a considerable amount of time. This is good news for investors. However, it marginally increased its interest rate projections for 2015 to 1.375% from the 1.125% projected earlier in June. Analysts suggest that the rise in interest rates could begin as early as mid-2015 or the second half of 2015. However, the Fed has not clearly indicated when it plans to do so. This has come as a relief to the markets. Hence, most stock markets reacted positively to the development.

FIIs and India markets:

Whenever the US Federal Reserve indicates a hike in interest rates, global markets could witness a selloff. India could be one of those affected like last year. This is because the foreign institutional investors control a sizeable chunk of the non-promoter shares traded on stock exchanges. When foreigners buy shares, Indian share values rise. Similarly, when they sell, prices fall.

What it means for India:

India may be shielded by a few positive factors. A decisive new government at power could mean better management of the budget and economic reforms. In 2014, most investors are betting on that. Central banks in Europe and Japan are likely to infuse liquidity into their markets to shore up the respective economies. This could inject money into the global markets to compensate for the fall in US.

Rupee:

The downside to the Fed's announcement is the impact on rupee. The Indian currency largely benefits when the US dollar falls.After the announcement, the US dollar rose to its highest against the Japanese Yen since September 2008. As a result, the rupee opened lower. However, the RBI is likely to intervene to stabilize the rupee. The other good news is that the rupee is supported by a fall in the current account deficit - the amount India owes to the world in foreign currency. Last year, it was one of the biggest reasons for the rupee's crash to Rs 69/$ - levels. This means, the rupee is not at a high risk for a free-fall like it did in 2013.

$15 billion

The US Fed has announced that it will be sticking with its path of tapering the QE programme down by $10 billion every month. This leaves a bond purchase of $15 billion in October. The Federal Reserve used to buy back bonds worth $85 billion when the programme was in full swing. Most analysts expect the QE programme will end in October, earlier than the initial forecast of November.

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