The irony for markets is that good news on the economy is actually bad news for asset prices. The reason is that a stronger US economy will lead to the Fed lowering and stopping its USD 85 billion a month bond purchase program in the coming months.
The market reaction post the strong employment data from the US on Friday the 6th of December was a positive surprise and if this is anything to go by, markets will welcome a Fed taper staring December 2013. The Fed will conduct its last meeting for this year on the 17th and 18th of December and markets are expecting a tapering announcement post the meeting.
The US economy added 203,000 jobs in November 2013 against a revised 200,000 job additions in October 2013. Unemployment rate in the US fell to five year lows of 7%, from 7.3% seen in October. Fed is targeting a 6.5% unemployment rate but will stop adding liquidity into the system as unemployment rate trends closer to 6.5%. The Fed will however keep interest rates at close to zero percent levels until 2015.
Equity markets rallied by over 1% post the job number release while the USD weakened against the Euro by 0.3%. Rise in equity prices coupled with a weaker USD suggest that markets are comfortable taking risk with the USD as the funding currency.
US GDP growth for the third quarter of 2013 came in at 3.6% against growth rates of 2.5% and 1.1% seen in the second and first quarter respectively. Core consumer price inflation was at 1.7% in October 2013, below Fed’s threshold rate of 2%. Consumer borrowing in October rose to five month highs and with consumer spending contributing to 70% of the country’s economy, rising consumer credit is a sign of higher spending.
US economy is adding jobs, the equity markets are at all time highs and property prices are rising and all this points to a stronger economy going forward. Low interest rates are helping the economy and the Fed is unlikely to pull the plug too soon on interest rates unless inflation expectations rise substantially.
The Fed withdrawing stimulus through asset purchase would be positive for the US and global markets. Markets will start believing that the US economy will hold its steady growth path without liquidity support and that will add to the perception of a stronger economy. Additional liquidity when it is not required creates asset bubbles and this policy makers want to avoid given the experience of 2007-08 global financial crises.
The Fed withdrawing stimulus through asset purchases coupled with a stronger US economy would benefit equities across the globe. The markets would not move on artificial liquidity but on stronger economic prospects. The Sensex and Nifty would benefit from rising global equities as would the Indian Rupee as capital flows rise on the back of stronger markets.