However, even if net treasury issuance is stabilised, the net balance sheet shrinkage will keep rising, leading to a double whammy for the global markets.
“Dollar funding has evaporated, notably from sovereign debt markets. Emerging markets have witnessed a sharp reversal of foreign capital flows over the past six weeks, which often exceed $5 billion a week. As a result, emerging market bonds and currencies have fallen in value,” Patel wrote.
While praising the US Fed for its flexible approach and effective communication on the withdrawal of accommodative stance, the RBI
governor said details of the tax cuts by US President Donald Trump
have been a surprise to the markets.
“Global spillovers did not manifest themselves until October last year. But they have been playing out vividly since the Fed started shrinking its balance sheet. This is because the Fed has not adjusted to, or even explicitly recognised the previously unexpected rise in US government debt issuance,” the RBI
governor said, adding, “It must do so now.”
According to Patel, the US Fed does not require to change the overall policy direction, but it can “simply recalibrate its normalisation plan, adjusting for the impact of the deficit.
The US Fed should reduce the pace of its balance sheet contraction to address the dollar liquidity shortage. Otherwise, the “sudden stop” of the global economic recovery would also hurt the US economy as well, Patel warned.