The Hindu Business Line : US recovery still key

At its Wednesday meeting, it left interest rates unchanged in the 0-0.25 per cent range. It was an obvious decision. The time is far from ripe to even contemplate hardening monetary policy.

At the same time, the Federal Open Market Committee (FOMC), which is in charge of monetary management of the gigantic US economy, thought it is unnecessary to augment the Fed’s liquidity infusion programme. This involves buying Treasury bonds and both buying and financing non-Treasury assets and was one of the major planks of the emergency rescue measures organised by the Fed last year, following the collapses of Lehman Brothers, Bear Stearns and AIG.

In what must be a big relief to the Obama administration and the Fed, at last yield spreads between non-Treasury and Treasury bonds have declined as has that between the interbank rate – LIBOR – and Treasury bill yields. The latter is down to less than 1 per cent, compared to 4 per cent + levels at the height of the financial market crisis. Long-term mortgage rates are below 5 per cent (but qualifying for one is the challenge).

It all represents easing of risk premiums. Credit and, equally important, liquidity conditions have improved significantly. Leading banks — both of the commercial and investment banking varieties — have started to report profits. (Nobel prize winning economist Paul Krugman raises an interesting and important question in this context — have they been churning cheap funds given by Government to make risk-free profits in the market?). But the prize, undoubtedly, will be stemming the unabated fall in house prices, which will do wonders for personal finances and the prices of mortgage paper.

What about the economy? The latest GDP data was worse than forecast, with an annualized decline of well over 6 per cent. But other figures — housing activity, house prices, business indices, consumer spending — suggest that the pace of deceleration is slowing. In other words, the situation, while not positive, is becoming less negative. As many point out, recovery is still a far cry.

Meanwhile, China is pulling all stops to make sure its economy does not slip into recession as a result of the crash in its US exports. It has replaced this with a domestic stimulus (and is well-positioned to do so with its huge unencumbered forex reserves), the results of which are already showing up in data.

Nevertheless, a US comeback remains fundamental to the global economy. Changing that will not happen overnight. Besides, it is linked to other critical issues such as a substitute for the dollar as a reserve currency and subjecting the US to the same financial discipline and rules as other countries.

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