Taper fear recedes but India is at the wrong end of the stick

Now that taper fear is behind us, the attention is back to domestic issues

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The Federal Open Market Committee (FOMC) made two announcements, one news was bearish while the other was bullish. Such is the buoyant mood in the US markets that it discounted the bearish news and latched on to the bullish one which in the end helped the Dow Jones close at its record high with a gain of 293 points.

The bearish news is about the start of tapering with a reduction in liquidity inflow by $10 billion, which many expected would only start in March 2014. Nearly sounding apologetic for starting tapering, FOMC also said that they would keep the short term interest rate near zero well past the earlier benchmark of 6.5 per cent unemployment rate. In effect this means that even though liquidity tap will be tightened at one end, funds will be available near zero per cent rates in the near term. In short the message that the market heard was ‘this is tapering and not tightening’, so let’s party.

While the stock market in the US shot up, short term yield in the bond market came down while the long term one increased marginally touching the 2.9 per cent mark reflecting the impact of liquidity on various asset classes.

Indian markets along with other Asian markets opened higher but saw selling pressure immediately. Around 11.30 a.m. India time, most of these markets were trading near the day’s low. However, Indian markets were the only ones trading in red with Sensex falling by around 150 points.

So why have Indian markets reacted so sharply. One plausible reason is that the fear of ‘Taper’ is now behind us which brings us back to domestic issues. And domestically there is nothing that seems to be working. RBI governor holding back from raising interest rates is being seen as a negative in many quarters.  His willingness to bring down demand if supplies are not picking up and the other structural issues that were highlighted in the speech will now be playing out. Results season and political turmoil will dictate market direction in near term; external fears have temporarily been addressed.

Also $10 billion taper is still a reduction in liquidity flow. Countries at the tail end of the liquidity pipeline like the ones in emerging markets will be one of the first ones gasping for air. Also, the 10 year bond nearing the 3 per cent mark leaves little room for bond arbitrage. Rupee currently trading at the day’s high of 62.48, reflects the fear of flows to the bond and equity markets.

The risk-on game is still on in the US, but movement of Asian stocks suggests that they are not invited to the game.