“The reaction is clear, there will be a gap down opening for the market tomorrow, what has to be seen is whether this sell-off is bought into or not,” said independent market expert Ambareesh Baliga.
The August futures of Nifty50 index traded on the Singapore Exchange were down over 200 points in trade today, suggesting a more than 1 per cent cut for the blue chip index on Friday. Indian equities were closed today on account of Muharram.
The minutes of the US Federal Reserve’s July meeting showed that most members were in agreement that the central bank has achieved its mandate on inflation even as they acknowledged that work still needed to be done on the labour market.
Further, Fed members debated at length on the withdrawal of the massive liquidity support with most seeing benefits of reducing asset purchase programmes. This led to speculation that the central bank will most likely announce the tapering of its massive bond buying programme initiated during the darkest hours of the pandemic in March 2020 by the end of the year.
European and other Asian markets fell sharply in reaction to the Fed’s minutes while US stock futures hinted at a sluggish start. The US Dollar index strengthened against a basket of currencies.
Is it too early?
In March 2020, the US Federal Reserve had cut interest rates to zero and announced plans to buy $200 billion of mortgage-backed securities and $500 billion of US treasury bonds. That plan was streamlined by December 2020 to $80 billion purchase of US Treasuries and $40 billion of mortgage-backed securities every month.
The massive liquidity pumped in by the US Federal Reserve into the US economy found its way out of the country’s shore into global markets aided by similar liquidity gushes released by central banks around the world.
That liquidity support proved pivotal in helping the US economy avoid a financial crisis during the first wave of the pandemic, given the onset of government-mandated lockdowns. The Fed’s swap lines were also activated to support developing and other developed economies because of a sharp drop in the US dollar supply in the global market caused by the halt in global trade.
Since then, the US economy has come roaring back and is expected to grow at more than 6 per cent in real GDP terms in 2021, the fastest growth in decades. Similarly, the global economy too has largely recovered from the shock of the pandemic barring the emergence of new variants such as Delta, which have caused the return of lockdowns in parts of Asia and Australia.
Federal Reserve member and President of the Boston Fed earlier this week said that he would favour announcing the taper programme in September if the central bank receives another solid labour market report. Other Fed members such as James Bullard have already suggested that they will back any tapering announcement.
Impact on India
In the event of Fed’s tapering of its liquidity, emerging markets like India will be at a disadvantage as foreign investors are likely to withdraw money and reinvest in US Treasuries and hoard the US dollar anticipating turbulence in foreign exchange market.
Currency traders indicated that with Fed’s policy normalisation becoming increasingly likely by the day, bets on the US dollar index rising will increase in coming weeks. Over the past two years, the Nifty50 has exhibited an inversely proportional relationship with the US Dollar index.
Baliga, however, suggested that Indian equities have recently shown tendencies of buying almost every minor correction in the market. The veteran analyst said that even a 5-7 per cent fall in the benchmarks will see buyers coming in.
“The market is generally very top heavy at the moment, so if these buyers don’t come in then the fall could precipitate,” Baliga warned.
