The Fed cut its bond purchase program of USD 75 billion by USD 10 billion in its January 28th-29th meet and has indicated that it will continue to taper by USD 10 billion every meet. However the Fed emphasized that interest rates will stay at close to zero per cent as long as inflation expectations do not rise above 0.5% over the threshold level of 2% and unemployment rate is above 6.5%.
US CPI is at levels of 1.5% while unemployment rate is at levels of 6.7%. Fed officials do not see any rate hikes until early to mid 2015 as they believe that inflation expectations are down and the economy is not creating enough jobs to sharply bring down the unemployment rate.
The markets reaction to the Fed taper was a fall in equity indices across the globe while US treasury yields fell and the USD strengthened against emerging currencies.
Indian markets saw a fall of over 1% in the Sensex and Nifty, a fall of 0.5% in the INR and a rise in ten year bond yields by around 6bps. This negative reaction is normal to say the least given that equity markets from the US to Japan have corrected by around 3% to 5% over the last three weeks while the Sensex and Nifty have fallen by around 1%.
The INR fall has been muted despite a steep fall in currencies such as Turkish Lira that is trading at record lows against the USD on political and current account deficit worries. Countries such as South Africa and Russia saw their central banks intervening in markets to stem currency falls. The weakness in commodity markets is hitting growth across commodity driven economies leading to sharp selling in their currencies.
The INR is not a commodity driven currency and the Indian economy has seen an improvement in its macro over the last one year. Current account deficit is down over 40% while RBI has raised rates to lower inflation expectations. FII’s have turned net buyers of INR bonds in the months of December 2013 and January 2014 with net purchases of USD 3 billion. FII’s had sold USD 10 billion of INR bonds in the June 2013 to November 2013 period leading to the INR falling to record lows against the USD.
The Indian economy is seen to have bottomed out in fiscal 2013-14 with growth at 5% levels. The economy is expected to show higher growth in 2014-15 and if there is a stable government at the centre post 2014 elections, the economy could gain traction.
The global correction in equities from record highs or multi year highs should be seen more of a temporary rather than long term correction as economic outlook is improving with IMF and World Bank raising global growth forecasts. The Fed taper is positive as it takes away excess liquidity that is being pumped into the system.