The US Federal Reserve in its last FOMC (Federal Open Market Committee) meet for calendar year 2013, clearly laid out a road map for taper of asset purchases. The Fed also lowered projections for the US unemployment rate at 6.3% for end 2014 as compared to initial estimates of 6.4% to 6.8%. The Fed’s statement on taper, rates and unemployment drove the benchmark US equity index the Dow to record highs.
The Sensex and Nifty will benefit hugely from the Fed’s policy of a calibrated taper of asset purchases as will the Indian Rupee (INR). The fact that RBI refrained from raising the repo rate in its 18th December 2013 policy review will add strength to the markets. It is well likely that the Sensex and Nifty will go into 2014 on a bullish note and the INR will strengthen against the USD. Sensex and Nifty at 20,883 and 6228 levels respectively are trading at 2% off record highs while the INR is up 10% from lows at Rs 62 to the US Dollar.
The Fed cut bond purchases by USD 10 billion from USD 85 billion to USD 75 billion in its December 2013 meet and indicated that it will reduce asset purchases in every meet going forward. The Fed maintained that interest rates will stay at close to zero per cent until the unemployment rate drops below 6.5% and inflation expectations rise to over 2%. Fed is looking at interest rates starting to move up in 2015.
The Fed will watch data for calibrating its taper. Strong data will increase the amount of taper while weak data will prompt the Fed to skip taper in its policy meet. US economy is showing signs of strength with unemployment at five year lows of 7%, improvement in the housing market given low interest rates, improved employment prospects and affordable real estate, rising consumer confidence and improved retail sales data. US equities are at record highs and with house prices rising, the wealth effect is kicking in to the economy.
A shale oil revolution that has seen its oil imports down 11% year on year in 2013 and the country producing more oil than it imports, the first time since 1996, help the US. Plentiful availability of oil and gas has kept fuel prices low and this is helping manufacturing industries with many US companies starting to relocate back to US from other so called cheap production countries.
The Fed’s stance of an easy monetary policy coupled with a strengthening economy is positive for US and global equities. Equity markets in US, Germany, UK, Japan and India are at record highs or close to record or multi year highs. The strong equity run will continue into 2014. The calibrated taper will help emerging market currencies that saw a sell off in the May – August 2013 period when first talks of taper emerged. The INR had touched record lows against the USD in August 2013 but has since then strengthened by 10%.
Bond markets reaction to the Fed policy will be positive, as the RBI will have more flexibility on its monetary policy given INR stability. Government bond yields reacted positively to a status quo on rate hikes by the RBI with yields falling by 10bps to 13bps across the curve. Bond yields will continue on its downward trend on the back of expectations of FII flows into INR bonds given expected stability in INR and given the high interest rate differential of 6% between US and Indian ten year bonds.