US Fed tapering to have an impact, but a limited one

The uncertainty around when the US Federal Reserve would start tapering off its quantitative easing programme is finally over. The Fed has announced that tapering will begin from January 1, 2014. It monthly bond buying will be reduced from $85 billion to $75 billion.

Tapering was bound to happen sooner or later. But it is important to understand that tapering will not be the end of quantitative easing. It will just slow down the pace of infusing money into the US economy by $10 billion a month.

Since 2008 the US Federal Reserve has pumped close to $4 trillion into the economy.

Besides, this reduction of $10 billion had been factored in by the market. It was expected for some time. In fact, that the reduction is so small has come as a sweet surprise, as markets the world over had been expecting a steeper cutback. Some had estimated the US Fed would cut bond purchase by $20-30 billion per month.

One of the reasons why the Reserve Bank of India (RBI) didn't hike repo rates (the rate at which the RBI lends to banks) in its policy review on Wednesday was that it was confident the Indian rupee had become stable at current levels and even an external event like the US's tapering would not have any major impact on it.

Finance Minister, P Chidambaram in a statement on Thursday stated that the government was better prepared than in May 2013 to deal with the consequences of the US Fed decision.

Fund  managers agree.

In a recent interview to Business Today, S Krishnakumar, head equity at Sundaram Mutual Fund said: "Even the RBI governor sounded more comfortable and prepared for the eventual tapering scenario, as well as with the reduced volatility in the currency. The eventual impact of tapering will depend on a variety of factors such as timing, quantum and forward guidance of the US Federal Reserve. We believe that the world over, market participants are better prepared for the event now than before."

STRONG DOLLAR TO IMPACT THE MARKET

Sentiments and liquidity are the only two factors that drive the markets and this is true for all asset class and across the globe.

For all of 2013 the market has risen purely on liquidity and not on fundamentals. The weakness in the US economy was the primary reason for easy money flowing into the Indian market.

But with the US unemployment rate falling to 7 per cent in November, the lowest since 2008, and other indications that the US economy is picking up a market like India's is bound to be adversely affected to some extent.

This is because of the weak currency. It's not just the rupee. Across the global all major currencies are trading weak against the US dollar. The dollar is gaining strength on the back of positive signals from the US economy.

The weak rupee will have an indirect impact on the market and that is the reason why the markets on Thursday morning were trading weak. The Sensex was down half per cent at 20,750 levels, while the rupee depreciated by 17-20 paise to trade at Rs 62.24 against the dollar.

US tapering can slow down the flow of money into our market and can put pressure on the Indian currency, which will be a dampener to our market and economy.

The silver lining is that the Fed will hold rates close to zero as long as the unemployment rate is above 6.5 per cent.

The Federal Open Market Committee (FOMC) expects the unemployment rate to hit 6.5 per cent by the end of 2014 and to fall to around 6% by the end of 2015. According to Bank of America Merrill Lynch, they expect the first rate hike in the first quarter of FY2016. It further adds that though there are short term hiccups, in the medium term the US recovery seems to be a positive for India.

US recovery would push up export demand and narrow current account deficit (CAD) and spur growth. The US recovery is also expected to stabilise oil and other commodity prices and help narrow current account deficit as well as contain imported inflation pressures.

By FY2015, the foreign brokerage expects oil to be at $105 per barrel which is currently hovering around $109-110 per barrel of oil.

Overall, until confidence returns and the investment scenario improves and growth goes back to the 7-8 per cent, the markets will remain volatile.