FOMC Members Split On How Long To Continue Asset Purchases

Minutes of the Federal Open Market Committee (FOMC) meeting of December 11 and 12 revealed a general consensus among participants on moving towards specific economic thresholds to guide future federal funds rate decisions.

Members were in less agreement on how long to continue the current asset purchase program. While some members noted that purchases would likely be warranted until late 2013, others expressed a view that purchases should end well before the end of the year. "One member viewed any additional purchases as unwarranted."

FOMC participants' economic outlooks were relatively unchanged from the previous meeting. Labor market conditions were noted to have improved but the unemployment rate remain elevated. Several members expressed concern that fiscal uncertainty was weighing on consumer and business confidence and leading firms to hold off hiring and investment.

Most members agreed that the housing market had shown clear signs of recovery and noted that "capacity constraints on the processing of new home-mortgage applications appeared to be easing, and gradually rising home prices had reduced the proportion of households with underwater mortgages."

Implications - Effect on USD/INR
Fed policy makers said that they will probably end their $85 billion monthly bond purchases sometime in 2013, with members divided between a mid- or end-of- year finish, according to the record of the Federal Open Market Committee’s December 11-12 gathering released Thursday. Bullion slipped 5.5 percent in the fourth quarter of last year, the worst showing since 2008, as improving economic data around the world damped speculation that central banks will need to add to stimulus.

The Fed’s minutes have led to a fall in commodities while the dollar has strengthened across the board. For almost a year, commodities rallied each time the housing and jobs data disappointed on hopes that Federal Reserve would add to its asset purchases. Henceforth, any improvement in the housing data and more importantly nonfarm payrolls data is likely to see a fall in commodity prices and a rise in the US dollar, as better than expected data will support Fed policy makers' decision to end QE sometime in 2013. The result is likely to be the reversal of last year's QE based rally.

The possibility of QE ending is also bearish for Gold. Going forward, Gold prices may witness a rally, possibly on the US debt ceiling issue and/or as the EU crisis intensifies. The BOJ’s possible decision of increasing inflation target to 2% may not have a substantial effect on Gold prices, as the BOJ has been conducting QE without much success since long before the word QE was coined.

The new development is equally bearish for the rupee. Moreover, the monthly inflation data is now more important for the rupee. Falling US Gold prices, sticky domestic Inflation – and add to that a possible rise in import duty on Gold may lead to a sharp rise in Gold imports. CAD may deteriorate further. Gold imports may remain high if monthly WPI data rises, RBI’s September survey of Household Inflation expectation shows that households expect inflation to rise further by 90 and 210 basis points during next three month and next one-year respectively from their perceived current rate of 10.6 per cent. Higher annual Inflation expectations plus low US gold prices are likely to weigh on the rupee.

It is highly unlikely that the rupee will appreciate substantially unless WPI Inflation falls to RBI’s comfort level, household inflation expectations decrease and a poor US economic data leads some or all Fed officials to comment on continuation of QE.

The monthly WPI data would be more important in deciding the movement of USD/INR pair. A hike in import duty will not matter much if Inflation expectatiosn remain high