MPC,Fedminutesandorderlyevolution

Yesterday was a big news day and presented itself with a lot of data points and policy documents to read and analyse. On the domestic side the MPC policy statement, the Governor’s address and finally the RBI’s post policy press conference provided lot of material. Globally we had FOMC minutes of last Fed policy getting released and there was a corporate tax change announcement by the Biden administration in the US. We will take all the points one by one.

Firstly, the MPC policy was on the expected lines as status quo was maintained on all the policy levers. One interesting development was putting in place the framework for secondary market purchase of government securities under the aegis of GSAP 1.0. Under which government announced that it will buy 1 trillion INR worth of government bonds in the first quarter. The first purchase to the tune of 25k Cr INR will be made on 15^th April. Deputy Governor Patra exclaimed during the press conference that first time in history the RBI is committing its balance sheet for the conduct of monetary policy. This has not been done by India ever before. It is different from regular OMO’s because it gives away the discretion and provides explicit assurance to the market on supporting the government borrowing program. He added that it is a challenging instrument, but the RBI is ready to take on the challenge. RBI Governor added that this is one more addition to the RBI’s toolkit to ensure “the orderly evolution of the yield curve”. We will discuss this in detail later.

In the US, FOMC minutes were released where the policy sentiment was echoed that easy policy conditions will remain till the stronger employment and higher inflation emerges on ground and won’t be adjusted just on the basis of forecasts. The 120 bn USD monthly bond purchase program is seen as providing support to the economy and is expected to continue at the current pace. On the other side the Biden administration unveiled a change in corporate tax codes to increase it from the current 21% to 28%. It will help in shoring up 2.5 tn USD over the next 15 years to finance the infrastructure proposals. The Dow Jones ended in slight green and US 10-year yield is trading at 1.67 currently.

Now coming to discussion on “Orderly evolution of the yield curve” requirement. As it is not a clear-cut requirement like a 4% average CPI target, let’s dig a bit deeper on every aspect of the statement to fully assimilate and appreciate the meaning. “Orderly” signifies without chaos, without many unpredictable ups and downs. Now to think of it, the order can either emerge spontaneously or it can be imposed. The markets generally create an equilibrium between the demand and supply by continuously discovering the clearing price at which the two shall meet. But this discovery is often not orderly, it is messy. On the other hand, if the price discovery is guided by some overarching tenets (think Nolan) put in place by the higher authorities (read central banks) then it can resemble order. Prices trade within a certain range. For example, the policies like Greenspan’s put, BOJ’s YCC are overarching guidelines which provide the markets an orderly character. Readers would however do well to remember that no order is permanent.

The second word which was stressed a lot was “evolution”. Things evolve over a period of time. Evolution involves things becoming better as they shed off the unnecessary parts and become more efficient. In the animal kingdom, evolution is a pre-requisite for survival. It is difficult to put in place what would evolution entail in case of yield curve but maybe it refers to evolving to an efficient price. Now efficient is another adjective and one should refrain from using adjectives un-necessarily. Efficient, correct, fair, optimal are adjectives in context of market prices can only be known in hindsight and sometimes not even with that. We would pause on our hair splitting here and rather take a look on how markets reacted to the same.

The 10-year benchmark bond came down post policy by 10 bps and is currently trading around 6.05. The Rupee had an unusually torrid day, weakening by close to 100 paise during the session. There was not much in the policy which can be blamed for such response.