Did the markets over-react to Bernanke's plan to unwind QE?

Downside risk to Asian equities from QE3 tapering looks limited but economic growth will be the key trigger

Ben Bernanke, the boss of Federal Reserve, set the cat among the pigeons on Thursday by saying the $85-billion bond buying programme would start winding down later this year and possibly even stop next year. Financial markets, which have been fuelled by this liquidity gush, tumbled across the globe, as it signals the end of easy money. So, have the markets over-reacted? Darren Gibbs, chief economist at Deutsche Bank Markets Research (Asia Pacific), says: "We must admit that we are a bit surprised at how far the market has run on these comments."

There are several factors that will come into play before the Fed is actually able to taper its bond purchase programme. For starters, any pullback by the Fed will be dependent on improving economic data. Only if the unemployment rate falls to seven per cent by mid-2014 will a complete withdrawal be possible. Strategists believe the Fed remains positive on growth in 2014 even though the 2013 gross domestic product (GDP) growth estimate has been lowered to 2.3-2.6 per cent levels from the earlier estimate of 2.3-2.8 per cent. Simultaneously, it has revised the 2014 GDP growth estimates upwards to 3-3.5 per cent from the earlier 2.9-3.4 per cent.

If the unemployment rate does not fall below seven per cent, then the planned exit from the asset purchase programme may get delayed. This is clear from his speech which is peppered with dovish statements like: "If the economy does not improve along the lines that we expect, we'll provide additional support. If financial conditions evolve in a way that's inconsistent with economic recovery, we will provide support." Neal Soss and Dana Saporta of Credit Suisse Economic Research are of the opinion that "monetary policy will remain exceptionally accommodative for years to come and that the first policy rate hike is not likely before mid-2015".

Even if interest rates were to rise in developed markets like the US, it is largely positive for India. Historically, rising bond yields in developed markets have coincided with strong equity returns in India, says Saurabh Mukherjea of Ambit Capital.

No doubt, news of a tapering in liquidity triggered a sell-off globally, Asia saw the worst kind of selling due to another reason. Asian equities are down 11 per cent from their May highs because of "heavy investor positioning". Given that Asia's growth isn't likely to match its past record, investors have reduced their overweight positions. Timothy Moe of Goldman Sachs estimates a downside risk for Asia (ex-Japan) equities at roughly five to eight per cent. Valuations, in fact, are rather attractive at this point. Historically, MSCI Asia (ex-Japan) has snapped back quickly, rising 12 per cent/20 per cent in the month/three-months after heavy selling in the market. However, this time such a bounce-back looks unlikely till economic growth revives in Asian economies.