US Fed prepping the markets for taper; a correction will be good: Analysts

The US Federal Reserve (US Fed) rejigged its expectations for inflation this year and signaled that it expects two rate increases by the end of 2023 as their Covid-impacted economy stutters back to life. However, the US central bank gave no exact date as to when the rollback of its bond buying program will begin. While the inflation projections confirm that the Federal Open Market Committee (FOMC) still thinks the current surge in inflation is transitory, they no longer feel comfortable waiting for 2024 to start the hiking cycle.

“The US Fed had to talk / hint about tapering plans with their economy growing at a healthy pace. The liquidity injection now is more than what is needed. The hint dropped on Wednesday does give the markets time to prepare and digest the US Fed’s plans. The markets have been running on steroids and some correction – even at the expense of a taper – will be healthy,” said Jyotivardhan Jaipuria, founder & managing director at Valentis Advisors.

Tapering of the $120 billion a month bond buying program by the US Fed, analysts say, will be clearer over the next couple of months. Before a decision on tapering can be made, the FOMC, they believe, will have to determine what constitutes ‘substantial further progress toward the Committee’s maximum employment and price stability goals.’

“The minutes of this week’s meeting will be released on July 7, and could give us more detail about the Fed’s tapering debate and plans. The fog over the data will not dissipate until the November meeting of the FOMC. However, a statement in November about a tapering decision in December or January may not be very much of an early warning signal. This brings us back to August (Jackson Hole) or September (FOMC meeting, with new projections),” wrote Philip Marey, senior US strategist at Rabobank International in a note.

Most Asian market equities – Nikkei, Sensex, Hang Seng and Kospi – lost ground in trade on Thursday as a result of the overnight development. The move, according to some analysts, is just a way of preparing the markets for the day when the taper actually starts.

“The US Fed is just prepping the markets for D-Day. That said, markets very well know that the US Fed will have to taper once the economy improves. The date announced by the US Fed is still far away and the global markets, including India will see a knee-jerk reaction at best,” said U R Bhat, managing director at Dalton Capital.

And this is not the first time that the global financial markets have to deal with this uncertainty. Back in 2013, too, the US Fed had said it would taper off its Great Recession economic stimulus by slowing down the pace of its Treasury bond purchases. As a result, bonds sold-off and Treasury yields surged.

“From the Indian markets' perspective, the upward revision in the inflation forecast has dampened sentiment. The biggest challenge for the Reserve Bank of India (RBI) will be the recent spike in consumer and wholesale price inflation in May'21 and the skepticism about its persistence. The unexpected spike in retail inflation does add to the uncertainty for the next MPC policy in August'21,” says Madan Sabnavis, chief economist, at CARE Ratings.

According to a recent BofA Fund Manager Survey for June, 63 per cent of the global fund managers polled between June 4 to June 10 that have $667 billion in assets under management (AUM) expect US Fed to signal taper in August (38 per cent) / September (25 per cent) 2021. Of those polled, 72 per cent believe that the inflation is ‘transitory.’

Foreign institutional investors (FIIs), Bhat of Dalton believes, can look at developed markets, especially the US, once the interest rates are raised there – but all this is well into the future.

“FIIs cannot completely ignore EMs. However, India has become less prone to what they do after the retail investors tightened their grip on the markets. FII flows are likely to continue at the same pace seen now till the time actual tapering begins,” he said.