Home >Markets >Mark To Market >Tapering is almost here but markets couldn't care less

The US Federal Reserve didn’t veer far from the expected script. That seems to have been enough for India’s equity indices to test out the potentially new highs on Thursday with both the Nifty and Sensex each gaining 1.6%. The evolving situation of China’s real estate giant Evergrande should keep investors wary, though.

The Fed’s statement said it would begin reducing its asset purchases very soon and may even finish tapering by mid-2022. A hike in policy rates, though, won’t be until 2023, the so-called dot plot, used by the Fed to signal its outlook for the path of interest rates, indicate.

This follows Federal Reserve chairman Jerome Powell’s statements last month at the Jackson Hole symposium, where he had first indicated a sooner-than-later taper.

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On Wednesday, Powell said there is merit in reducing asset purchases soon as the threshold conditions for the same have been met.

What’s more is that the Fed would be reducing its accommodation even though it expects the US gross domestic product (GDP) growth to be lower by a big margin and for inflation to exceed previous estimates.

While these may seem ominous for markets propped up on dollar liquidity, investors are taking comfort from two factors. One, dollar liquidity is unlikely to reduce quickly in global financial markets. That means the recent foreign fund inflows into domestic equities may not wane. Foreign portfolio investors have poured in $2.89 billion into domestic equity and bond markets so far this month. Since January, inflows add up to $12 billion. Second, the path towards rate hikes is much slower than taper.

“The bottom line here is that tapering is imminent, but (I) expect chair Powell to push back on the timing for rate lift-off, emphasizing the uncertainty and likely reasserting his view that the rise in inflation will prove transitory," wrote Ian Shepherdson, chief economist of Pantheon Macroeconomics, in an email response.

“Ultra-low interest rates will be around for at least until 2023 and Powell’s comments indicate that the Fed won’t raise rates quickly. This is good for equity valuations in emerging markets," said an analyst requesting anonymity.

The lack of tantrum can be attributed to Powell’s careful communication in preparing markets on taper for some time now. But perhaps the markets’ rather sanguine response to the Fed statement bears caution.

Here, signs that China was willing to soften the impact of Evergrande on financial markets by infusing some short-term liquidity seem to have also calmed the nerves. But Evergrande is an evolving situation and there are signs of trouble for demand slowdown from China.

Analysts from Nomura, however, point out that the impact on India from China’s slowdown or even a financial turbulence would be less than most other Asian peers. “Our analysis suggests Australia, Singapore and Malaysia will be most impacted by slowing demand from China (real channel), while Hong Kong, Singapore (again), Taiwan and Korea are most exposed via the financial channel," the firm said in a report.

“As such, even if asset markets stabilize, the economies exposed via the real channel may face headwinds over the medium term, given our China team’s view that the economic slowdown will worsen." The Fed indicated that the risks from Evergrande looked to be manageable right now.

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