The coming week will answer the biggest
question that is on every investors mind – Will the Fed taper?
The Federal Open Market Committee (FOMC),
the policy making arm of the U.S. Federal Reserve, will get into a two day huddle next week ( September 17-18) and
decide whether to start winding down its $85 billion a month purchase of
mortgage-backed securities and longer-term treasuries.
Bernanke made it quite clear in his
testimony earlier this year in May that the Fed will have to start winding up
its aforesaid bond buying programme sometime later this year.
As a result of this announcement, the bond
yields in the 10 year paper firmed up to the current 2.9% from the level of
1.9% prevailing in May.
As the yields in the U.S. rose, foreign
investors demanded higher yield for their emerging market paper. The FIIs in
India sold off with in a month whatever bonds they had bought in the calendar
year till the month of May. The currency depreciated, which raised the hedging
costs and as a result the desire for higher yields. We all know how the Rupee
tumbled to 68.8 versus the U.S. Dollar.
Courtesy a series of steps taken by the new
Governor of Reserve Bank and resumption of fresh buying by FIIs the Rupee has
clawed back to the current levels of 63.46 to the Dollar.
As things stand today, with the Nifty at
5828, and having seen a plunge to the levels of 5118 in August, it is perfectly
logical for the investor to get worried about the Fed taper.
The Fed’s balance sheet has ballooned to
about $ 3.6 trillion with all the quantitative easing. All this liquidity has
helped increase the investments in risk assets such as equities globally. As
this liquidity dries up markets could suffer.
The Fed has laid down clear targets of
Unemployment Rate of 7% and an inflation rate of 2% for it to stop the stimulus
to the economy. The Unemployment rate currently is at 7.3%. So it must begin to
wind up the easing this month if it is to meet its March 2104 target of ending
the stimulus.
The economy is not showing the signs of
robust growth which were evident in June. The average job creation for previous
months was around 1,99,000. The revised data is much lower at 1,64,000. The
retail sales, which power the U.S. economy also grew at a much slower pace in
August at 0.2% as against expectations
of 0.5%.
While the Fed may have to begin tapering
from this month, it has to ensure that it does not smother the growth of
nascent U.S economy.
We believe that the Fed could taper but
will do an only notional job of it. We think winding up the stimulus by $ 10
billion is likely to be in order.
While a lot depends on how the markets
perceive it, our sense is that the markets have already priced in a $ 10
billion taper. Anything less than that will surely come as a pleasant surprise
and will buoy the markets.
Since the Fed buys both the treasuries and
mortgage backed securities, the cut is likely to be in the treasury buying as
housing is too important for the U.S economy to be touched at this point of
time.
But in the event that the Fed does not
taper, the markets will rock .
Vinod Sharma
Business Head - Private Broking &
Wealth Management
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