EASING OF QE - MARKETS WON'T FALL OFF THE CLIFF!
By Ruma Dubey
The money printing press in USA to stop? Now, for that to happen, surely a miracle would be needed!
The US Federal Open Market Committee (FOMC) meeting starts today. As usual, there is a buzz around the meet and as has been since the past couple of years – the buzz remains about Quantitative Easing (QE). The only difference is this time around the expectations are not about QE4 but indications about easing out QE. The emerging markets have had the time of their life with QE1, QE2 and then QE3. As all good things come to an end, Ben Bernanke has already indicated that he will soon be looking at easing out the stimulus as the US economy is showing signs of a bounce back. And this FOMC meet will give us an indication of precisely this easing.
QE essentially means that the US Govt printed more dollars to buy up assets like long-term Treasuries or mortgage-backed securities from commercial banks and other institutions. This was done to keep long term interest rates near zero and spur people to spend more and bring down the recessionary trends. With so much money printed, tonnes of this money has come to emerging economies.
Naturally, the emerging markets, especially India and China are a worried lot as this could mean that FIIs could start pulling out money. There is worry that the speed in which money could get withdrawn could lead to a virtual crash. This stems from common sense and some historical data - when QE1 had ended in 2010, by end of June that year, S&P 500 had dropped by an alarming 15%. And when the Fed indicated that QE2 would be coming in, the stocks bounced back.
Is there a real fear of emerging markets crashing through the floors of trading? Logically, a crash into a bottomless pit will not happen. Two factors support this belief. Firstly, when stimulus was withdrawn in 2010, the world economies were fragile, still hurting and nursing the wounds inflicted by the collapse of Wall Street. This time around, economies are showing signs of resurgence though Europe continues to limp and more importantly, the US economy is also slowly but surely getting back its vigor. It will take a while for growth to take off but at least it’s not a death knell situation any more. Yes, when QE gets withdrawn, there will be a reaction but it will not be a crash. If the market looks at the end of QE as a sign of confidence building up in the economy then the rally could indeed continue. Also one has to remember, it is not the money from Fed alone which drives stock prices – it is corporate performances too and individual companies have started showing better profits and margins, thanks to various cost cutting measures and improving production efficiencies. This means hard times have made companies leaner, fiscally more prudent and efficient.
One can brush off this logic as too Utopian but then the second factor more or less will drive home the truth. Let’s take the case of US Treasury. The US ‘prints’ $85 billion per month and that means it is buying bonds of this value per month. When FIIs get the money, they put it in emerging markets to take advantage of the arbitrages. When the money goes to that country, say, India, it will come in the form of dollars which will be with RBI. Now it is foolish to let so much money sit idle, so RBI utilizes this money itself to buy US Treasuries. So money comes from USA and goes back there.
As per the US Treasury records, in April’13, India held $53.5 billion worth of US Treasury Securities. India has been bringing this holding down consistently, from a peak of US$60.6 billion in August’12. Yet, it remains higher than US$49.3 billion held in April’13. China remains the number one holder – till end of April’13, it held US$1264.90 billion worth of US Treasury securities. Japan comes in second place, holding US$1100.30 billion. (Take a look at the major foreign holders of US Treasury securities - http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt)
So when the FIIs start exiting, the RBI would need to give them back their money and to raise money, naturally, it will have to sell its US Treasury holdings. Can you imagine what will happen to US if India, China and other economies, all start selling the Treasury securities, even if at a loss? The US economy could collapse. Now that is something which the Fed will not allow to happen. And that brings us to the conclusion – the easing of QE will not lead to stock markets crash; thus the Fed will ensure, for the safety of its own economy, to ease this QE in a slow and gradual way. For eg: if it is pushing $85 billion per month, this could be cut down by 10% first, then maybe another 10-15% and so on. But it will not be a complete stop at one go. That would be disastrous for the entire world. And this is what the Fed is likely to convey in today’s FOMC meet – when and how much..
In all Hollywood movies, USA always saves the world from alien attacks and other disasters; so in real life, how can it allow the world to collapse? Now this logic surely makes more sense than the other two!
What do investors do? Do not sell on panic. Buy on weakness, which will be plentiful in the coming months. Hold for the long term.