Whose monetary policy is more important for the Indian equity markets, the Reserve Bank of India’s (RBI) or the US Federal Reserve’s? The answer to that question was evident on Thursday, when the Sensex moved up 2.09%—on the day of the RBI’s credit policy, it was flat. Clearly, equity markets not just in India, but across the world march to the beat of Ben Bernanke’s drum.
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Emerging markets were the main beneficiaries of QE1 (quantitative easing 1) and there’s no reason why QE2 will not work in the same way. Of course, valuations are now much higher than when QE1 was in place, so the risks are greater. But the Fed’s statement on Wednesday had a clause that said the quantum of QE2 will depend on the circumstances, which makes the amounts almost open-ended. QE is the last weapon in Fed’s arsenal and it seems to be determined to use it to the hilt, never mind its effect on other economies. Analysts have already started talking of Fed expanding the programme if it doesn’t get the desired results. In any case, with assured funding at near-zero per cent in the US for an extended period and with return on equity in excess of 20% in markets such as India, the arbitrage trade is a compelling one, especially when you get the added bonus of rupee appreciation to add to your returns. There is little doubt that the market’s ride on the QE bubble will continue, though initial public offerings, follow-on issues and high commodity prices could act as a drag.
For the moment, the market is relieved that Fed has lived up to its expectations. The relief in the US markets was evident from the movement of the US VIX, the volatility index, which saw a drop of 9.3% on Wednesday. In India, the National Stock Exchange’s VIX index dropped 10% on Thursday, a sigh of relief that the event passed off well.
As expected, the dollar fell, commodity prices moved up and crude oil prices crossed $85 (Rs 3,766) a barrel. Interestingly, though, the local 10-year bond yield went up a bit. Shouldn’t bonds too have risen, driving down yields in the expectation of foreign institutional investor money flowing into bonds? The rise in yields seems to suggest the bond markets, at last, are aware of the implications for inflation.
Graphic by Yogesh Kumar/Mint
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