Quantitative easing of less than $500 billion in the US could see markets correct by 3-5%.
QE expectations
Post the 2008 crisis, the central banks of many developed nations took various measures to spur growth and employment. While a lot of money was pumped into the economy (the US itself saw an infusion of $1.7 trillion) and interest rates were lowered — already near the zero level currently — these measures haven’t yielded the desired results. As another step in this direction, the US is now expected to announce another set of quantitative easing measures or QE2.
As a result of QE2, the banking systems are expected to be flush with additional liquidity, part of which could find its way into asset classes like commodities and stocks, particularly those of emerging countries which offer better growth. Experts, though, say a lot of this money has already flown into emerging markets in anticipation of the easing, which is why we have seen strong inflows of foreign money in October.
The impact on various asset classes will depend on the money flow, which in turn will depend on the QE2 amount and the Fed’s indication of the future. So, what are the expectations on this front? “The markets were earlier sensing a $1 trillion kind of quantitative easing, but the expectations have come down to $500 billion, which is already factored in by the markets. In my view, the most likely scenario is that the Fed might announce $500 billion of quantitative easing scattered over a period of time starting with $100 billion, in which case the equity markets and all other risky assets will be disappointed,” says Abheek Barua, chief economist at HDFC Bank. Economists at Nouriel Roubini’s team say, “Under our baseline scenario, to which we assign a 60 per cent probability, the November FOMC meeting statement will announce a large-scale asset-purchase programme (LSAP) of roughly $600 billion.”
Likely impact
“The markets are factoring in about $500 billion of easing. If the amount is lower, the immediate reaction would be a correction of 3-5 per cent in the markets,” says Deven Nevgi, Founder & Principal Partner, Delta Global Partners. Some others believe the correction could be as sharp as 10 per cent in case of disappointment, given that the last leg of the rally (in India) was driven by strong flows of money and the valuations in many cases are not favourable.
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On the other hand, Raamdeo Agarwal, Director & Co-founder of Motilal Oswal Financial Services, believes even if the QE2 figure comes at $500 billion, it could mean more fund flows to Indian markets.
Back at home
The RBI, too, will meet on November 2 for its policy announcements. While some expect a rise of 25 basis points in interest rates, which could increase cost for India Inc, economists like Barua believe the RBI may not raise rates this time, given that it will result in interest rate differentials (between India and other countries) and result in attracting more money to the country and, thus, influence the rupee.
In this backdrop, investors could expect some action in commodities stocks. “Quantitative easing will result in low rates and higher liquidity, which is good for any asset class. Positive QE announcements will leading to higher demand and prices for commodities. But, as of now we don’t know how much is factored in,” says Gopal Agarwal, head, equities, Mirae Asset India. In anticipation of QE2, commodities stocks have already seen some appreciation.
“Overall, flows are being driven as much by some long-term stories, which aren't going to go away anytime soon, as they are by one-off events. Over the next three to five years, emerging markets (EM) will almost certainly grow on average at 2-3 times the rates of developed markets and their currencies will appreciate versus the US dollar, two themes that will keep money pouring into EM assets,” says Cameron Brandt, senior analyst, EPFR.