FEAR NOT THE TAPER!

about 28 days ago
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Tapering will happen. That is one certainty but the timeline – end of this year or early next year remains uncertain.

There are many traders in the market who feel that the markets will fall through the floor once the Fed actually announces the taper timeline.

But then these are people who probably were not around when 2008 happened or are have learnt nothing from history.

The Fed has shown the world that is does not do anything which will rock the global boat. The tapering of the QE of 2008 and later was done in a very gentle, phased manned from 2014 into 2019. And by the time it actually began the tapering, all were mentally prepared- there were no knee-jerk unpleasant surprises.

The fear of many – FIIs will scoot, lock-stock-barrel.

Unlikely. FIIs simply cannot afford to move out lock, stock and barrel out of India as the opportunity that the country presents it too good to ignore.

What we are witnessing now and will see in the coming days, will be a very logical reaction to tapering. It does not mean that they are getting out due to systemic issues.

Logically, a crash into a bottomless pit will not happen. Two factors support this belief. Firstly, when stimulus was withdrawn in 2010, the world economies were fragile, still hurting and nursing the wounds inflicted by the collapse of Wall Street. This time around, economies are showing signs of resurgence though Europe continues to limp and more importantly, the US economy is also slowly but surely getting back its vigor. It will take a while for growth to take off but at least it’s not a death knell situation any more. Yes, when QE gets withdrawn, there will be a reaction but it will not be a crash. If the market looks at the end of QE as a sign of confidence building up in the economy then the rally could indeed continue. Also, one has to remember, it is not the money from Fed alone which drives stock prices – it is corporate performances too and individual companies have started showing better profits and margins, thanks to various cost cutting measures and improving production efficiencies. This means hard times have made companies leaner, fiscally more prudent and efficient.

One can brush off this logic as too Utopian but then the second factor more or less will drive home the truth. Let’s take the case of US Treasury. The US ‘prints’ $80 billion per month and that means it is buying bonds of this value per month. When FIIs get the money, they put it in emerging markets to take advantage of the arbitrages. When the money goes to that country, say, India, it will come in the form of dollars which will be with RBI. Now it is foolish to let so much money sit idle, so RBI utilizes this money itself to buy US Treasuries. So, money comes from USA and goes back there.

As per the US Treasury records, at end of June’21, India held $220 billion worth Treasuries. Japan is the number one, like always, at $1277 billion and second is China at $1062 billion. (Take a look at the major foreign holders of US Treasury securities - http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt)

So, when the FIIs start exiting, the RBI would need to give them back their money and to raise money, naturally, it will have to sell its US Treasury holdings.  Can you imagine what will happen to US if India, China and other economies, all start selling the Treasury securities, even if at a loss? The US economy could collapse. Now that is something which the Fed will not allow to happen. And that brings us to the conclusion – the easing of QE will not lead to stock markets crash; thus the Fed will ensure, for the safety of its own economy, to ease this QE in a slow and gradual way.

More than tapering, what we probably need to fret about is when the rate cycle turns around – historically it has been seen that when the Fed hikes interest rates, that’s when FII inflows come down. Currently, the huge inflows we see are thanks to the near-zero interest rate. A rate hike removes or reduces arbitrage opportunity and that should be the concern and not tapering!

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