Mumbai: The much-awaited two-day FOMC meeting of the US Federal Reserve began yesterday. The markets expect the central bank to announce new measures to revive the US economy which is saddled with high unemployment.
A widely expected measure is ‘operation twist,’ which involves Federal Reserve buying long-term bonds by selling short-term notes. The measure is reportedly untested in recent times and will flatten yield curve, keeping interest rates even lower. Read more...
A fresh stimulus will have mixed ramifications for the Indian markets. With high inflation, tight monetary policy, slowing economy and a policy logjam weighing on the investor sentiment, Nick Paulson-Ellis of Espirito Santo Securities does not expect stimulus measures to drive returns in the domestic markets.
He writes: In India, the experience of QEI and QEII was contrasting, just as the quantum was materially different (QEI $1.3 trillion, QEII $600bn). QEI saw 100% returns in India, QEII negative returns. India saw high inflows during QEI, limited during QEII. Cyclicals outperformed during QEI, defensives during QEII. Domestic Indian factors came to the fore during QEII, and it proved not to be a major determinant of returns.
We suspect the same will be true about Twist – it is important to monitor how its impact evolves, but it shouldn’t be a major factor in portfolio decision making in India. The impact is most likely to be felt in overall flows into emerging markets, and providing some support to commodities prices which should otherwise be weakening with sagging global demand.
During the first quantitative easing (November 2008-April 2010) the benchmark stock market index Sensex has almost doubled from 9,000 levels to 17,600 levels. However, the QE2 program proved to be less yielding. As Federal Reserve unveiled the second round of quantitative easing in November 2010, Sensex has fallen from 19,500 levels to around 18,000 in June (when QE2 ended) this year.
While the Federal Reserve’s decision will be out by midnight, infusion of fresh liquidity might not do much good for the Indian economy. Experts fear that fresh liquidity will drive commodity prices higher, hurting countries like India. Commodities stood as the primary beneficiaries of the second round of quantitative easing. Both the Brent crude and Jeffries CRB Commodity index bounded up by over 20% each during QE2.
Like Nick Paulson, Jay Shankar of Religare Capital Markets fears that fresh stimulus will drive commodities higher, which in turn could hurt the Indian economy.
Jay Shankar, Chief Economist, Religare Capital Markets says:
The format might be different. But the Federal Reserve’s measures, in essence, are expected to result in liquidity infusion. The measures will increase inflows into the risky assets; thereby aiding the emerging markets in the short-term. From India perspective, liquidity infusion will lend support to commodities like crude oil. This could further spike the inflationary pressures, increasing the downside risks to the economic growth.
Infusion of fresh liquidity could send domestic markets higher for a day or two. But in the long run, greater liquidity will do more harm to the Indian economy.
Dipen Shah, Head of fundamental research at Kotak Securities says:
If the Federal Reserve decides to infuse liquidity it will be positive for the stock markets. Global markets will rise, which in turn could send Indian stocks higher. But from the economy perspective the liquidity infusion will be a cause of concern. Monetary easing will send commodity prices higher. This will hurt Indian companies. So initially equities might rise, in the long run the valuations will come under pressure due to high inflation.