Tapering – Further Acceleration Expected

The Fed Chairman, in his testimony to the Senate Committee, made some meaningful observations, which point towards a potential Fed action in the near future. First, there is a realization that inflation is not transitory or transient anymore. Inflation is going to stay high, and policy needs to address this emerging requirement. Second, there is probably a need to reduce the bond buying program. As against the original program of US$ 120 billion, the Fed had decided to reduce the buying by US$ 30 billion per month. This will ensure a closure of the liquidity expansion in another three months, instead of the original 6 to 7 months. But it may be recalled that while initiating the tapering of the bond purchase program the Fed had indicated, that they would calibrate the program in response to the future developments in the economy. Therefore, this does not come as a major surprise for market participants.

The Fed is gradually moving towards a possible rate action in 2022. This is quite evident from the Fed Chairman’s statement. There is a general view that Fed may hike rates by 0.25% each time, and about three to four times during the course of 2022. However, it may be borne in mind that any flare up of the pandemic, with the more infectious new variant, may lead to economic slowdown and therefore, a serious review of the policy if it comes to that. But it is hoped that an economic disruption of the magnitude seen last time could be ruled out. Therefore, the obvious impact which these measures will have on the markets would be a spike in the money market rates, followed by higher treasury yields, and more strength to the US Dollar.
The latest inflation number at 6.80 %, the US has recorded the highest number since 1982, and this may rattle the policy makers because the US policy making is known for pre-emptive strikes, and not action after the event. With economic growth well on its course, and the price level certainly is a matter of concern with the readings for consumer confidence edging lower. The acceptable average inflation level, historically, for the US economy is around 3.00 % to 3.50 %, and any inflation level higher than this would gradually start affecting the economy and the asset markets, especially the equity markets. At this time, the average inflation is inching higher towards this mark. Therefore, anti – inflation policies matter for long term sustenance of economic growth.

China, is set to continue its policy of easy money with an eye to protect the interests of and foster small and medium enterprises. The objective on growth is a potential growth between 5 % and 6 %. Though the second largest economy recovered from the pandemic induced disruption quite fast , in the last two to three quarters the growth momentum seemed to be waning due to multiple factors including the institution of certain new local restrictions on fears of a revival of the pandemic in isolated pockets. Apart from this, there are two reasons due to which China may continue with the easy money policy. The first is that the regulatory overreach of tech companies brought in enormous amount of negative publicity as also a certain amount of distress among the companies in the sector. Stocks were sold off and the equity market looks attractive on a relative basis more than at any time in the past. A second, and more important factor is the doldrums in the realty sector with many large companies facing repayment problems calling into question the viability and stability of the sector itself. While some of the repayments have been managed so far, the problem lies deeper and could be resolved only by the provision of cheap liquidity and support from the government for an extended period of time. The first wave of the repayment issues seems to be over, but the second wave could be soon in the coming. This highlights that country risk, with concentrated portfolios is something that should be taken with extreme caution, and that diversified portfolios are the obvious answer.


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