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Two big events this week – the Federal Open Market Committee (FOMC) meeting on Wednesday and RBI’s policy review on Friday – will determine which way equity markets head in the coming weeks. Since June, the Federal Reserve has been looking to taper its $85 billion a month bond buying programme, which sent markets (commodities and equities) running for cover. The FOMC’s meeting is crucial for emerging markets like India because over the last few years, financial markets have been fuelled by easy liquidity. For instance, since 2009, over $100 billion has flowed into Indian equities. Not surprising them that the talk of a possible taper from this month has sent risk assets and commodities into a tailspin. Brent crude futures have remained subdued ahead of the FOMC’s meeting on 18 September as have equities.
So are the taper related fears unfounded or are they real? To begin with, markets have already priced in tapering from this month. However, if the Fed tapers its bond buying by $10 billion, the impact on financial markets would be negligible. If the taper is higher than $10 billion per month, markets may roil. According to a Barclays survey, conducted among 800 global investors, 64 per cent of respondents believe tapering will start this week and almost all of them expect it to occur before the end of the year. Investors now perceive the removal of Fed stimulus will start earlier, the survey says.
Forty five per cent expect the Fed to finish their open-ended QE3 program in Q2 2014, while most respondents in our June survey thought it would happen in Q4 2014 or later. Interestingly, most investors believe that equities have become less attractive, they have shown a slight increase in their preference for emerging markets and commodities from June. Barclays says: “The perception of key risks has also shifted. Last quarter, a reduction in Fed policy stimulus was seen as the key risk for markets by nearly 40 per cent of survey participants; today, the number is just 26 per cent.”
Several economists in the US believe concerns regarding a taper could be premature as growth data continues to be weak and the Fed does not want “risk off” trades just yet. Talks of a taper have pushed up interest rates in the US by over 100 basis points and any further increase would impact growth. For starters, it is believed that growth has slowed in the third quarter (quarter ended September) from the 2. 5 per cent seen in the second quarter. Economic growth bottomed out in the fourth quarter of 2012 when it touched 0.1 per cent.
While there is no doubt that the growth is picking up, questions remain on how sustainable this growth would be without the stimulus. Since the Fed met at the end of July, there have been 21 growth-related data releases. Of these 21 releases, eight have been above consensus, one has been on consensus and the remaining 12 have been below consensus. New home sales in the US in the month of July have fallen by 13.4 per cent. According to a Bank of America Merrill Lynch report, “While it remains a close call, we are still in the December camp when it comes to Fed tapering. All of the acceleration in growth over the last two quarters can be accounted for by the swing in inventory investment.”
