The major reason for the consideration of tapering is strong employment in the US in the past two months and the evolving economy with inflation reaching 2 percent.
Source: Reuters
The highly anticipated global event over the US Fed tapering came into the limelight in the recent Fed Reserve announcement by chair Jerome Powell. The Fed reserve hints to reduce its monthly bond purchases in the current year, however, the rise in interest rate would still be on the sidelines for the time being.
The major objective for the central bank over buying bonds is to reduce the interest rates and induce liquidity into the economy in situations like economic slowdown or epidemic/pandemic, where the commercial banks restrict themselves to provide loans as the probability for them to become non-performing assets (NPAs) goes higher. Thus to maintain a stable and growing economy the US Fed applies the expansionary policy (lowering interest rates) and also through Quantitative easing i.e. buying bonds. And that is how the Fed appends new money in the economy and lowers interest rates to bidding up fixed income securities resulting in expansion of the central bank’s balance sheet.
The major reason for the consideration of tapering is strong employment in the US in the past two months and the evolving economy with inflation reaching 2 percent. However, the US employment is still below the pre-pandemic zone and the recent spread of the delta variant still holds the uncertainty of the future prospects. Thus the status-quo remains for the time being. But the hint for tapering has already spread globally making it evident that how the US Fed wants to support the economy through quantitative easing (QE) by reducing long-term interest rates and making business borrowings cheaper. Thus once tapering is complete then the Fed may reduce the size of their balance sheet and slowly dispose of the monetary stimulus.
As the process of tapering or reduction has yet not started it has been making the market fully equipped for the same as when the time comes. The immediate consequences could be seen across the global markets especially in the emerging economies. The emerging countries like India where the apex banking system is strong and is visionary have already bulked up the foreign reserve by accumulating foreign exchange reserves to the tune of $ 612 billion. Along with foreign reserves, the interest rate of 4 percent is the lowest sustained rate that India has seen in its entire history. Not just RBI reverse repo rate, all kinds of rates right from home loans, vehicle loans, and personal loans are at their lowest level for a long stretch. This helped valuation in two ways – cash flows are discounted at lower weighted average cost of capital (WACC) and positive impact on earnings yields. The lower interest rates have also helped India to deleverage its balance sheet.
The effect of the tapering would relatively be low for our domestic market as apart from strong fundamentals the liquidity plays a vital role to boost the overall sentiment and economical well-being. The stock market is already in a secular uptrend and some correction cannot be ruled out but with the strong fundamentals, the market is being provided with proper cushioning and i.e. expected to maintain the bullish momentum for a wider time frame.
Considering all the upcoming events, it is advisable to keep the cautious approach in the market as along with economical events one should not overlook the risk of spread in delta variant and its further development. Investors should keep up the balance of their investment portfolio with diversity as going forward, the returns would be driven by stock selection irrespective of their market capitalization and size.
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Osho Krishan
