TAPERING – FINALLY ITS HAPPENING!

As we in India get ready to begin our four-day Diwali celebrations, the Federal Reserve in USA is getting ready for taper.

It was a foregone conclusion that the Fed will start reducing the biggest bond-buying program referred to as ‘taper’ and that’s what the Fed did.

The US Central Bank will begin reducing its asset buying by $15 billion/month from mid-November. This means the expansion of Fed’s $8.6 trillion asset portfolio will end by June’22. Since the corona virus struck the world, the Fed brought down its interest rate to near zero and it has been buying $120 billion a month in Treasury and mortgage securities.

More than the taper, the attention had diverted to how the Fed will manage inflation as that is what will mark the reversal of the interest rate trajectory. It is clear that the Fed does not want to start hiking rates will it has ended the bond buying, which means, rates will be kept status quo till summer of 2022. But then, the question is – if inflation starts getting ugly, will the Fed accelerate its taper to enable an earlier rate hike? And in answer to this, the FOMC statement stressed that the Fed is not on a preset course and will make adjustments to the process if necessary.

The Fed this time around did acknowledge that inflation is “elevated, largely reflecting factors that are expected to be transitory.”

What we are seeing now is a journey back to a more neutral policy stance after almost two years of doing everything to prop up financial markets.

So what happens to the Indian markets post this news? Well, to a large extent the markets have discounted tapering but this is likely to cause ripples, yet it will not fall off the cliff as the tapering amount is as expected. The markets may not react as much as they did last time when the US Fed had first announced tapering.  The market should remember that this tapering indicates that the US economy is slowly but surely getting better and we, along with other emerging markets could benefit from exports to US.

And FIIs will not scoot, as they simply cannot afford to move out lock, stock and barrel out of India as the opportunity that the country presents it too good to ignore. What we are witnessing now and will see in the coming days, will be a very logical reaction to tapering. It does not mean that they are getting out due to systemic issues.

Logically, a crash into a bottomless pit will not happen. When stimulus was withdrawn in 2010, the world economies were fragile, still hurting and nursing the wounds inflicted by the collapse of Wall Street.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.

More than tapering, what we probably need to fret about is when the rate cycle turns around – historically it has been seen that when the Fed hikes interest rates, that’s when FII inflows come down. Currently, the huge inflows we see are thanks to the near-zero interest rate. A rate hike removes or reduces arbitrage opportunity and that should be the concern and not tapering!