It's curtains for QE3, long live easy money

Bernanke softens taper blow by committing to keep rates low till 2015; EM currencies unlikely to see bloodbath

Federal Reserve chief Ben Bernanke has concluded his term by signalling an end to the fiscal stimulus programme, better known as quantitative easing (QE). The third edition of the stimulus programme began last year, under which the Fed was buying $85 billion worth of assets every month. This will be cut by $10 billion from January 2014. Michael Gapen of Barclays Economics Research believes similar-sized reductions will be announced at each of the meetings of the Federal Open Markets Committee. This implies QE3 is expected to conclude by October 2014.

Does this mean the era of easy money is over? Clearly not. While cutting QE3, Bernanke has maintained policy rates would remain low till unemployment did not fall to six per cent and inflation did not touch 1.5-2 per cent levels. Samir Tripathi of ICICI Global Markets believes the Fed neutralised the impact of the taper with dovish forward guidance on its funds rate. He says, “The Fed officials’ median estimate for the Fed funds rate suggests interest rates will remain low for long (ie, 0.75 per cent by end 2015 and 1.75 per cent by end 2016), which is positive for risk assets.”

Policy rates are relevant not just for the US but also for emerging markets like India because they have been recipients of large sums of capital. Once interest rates in the US move up, this capital may flow back home if rates rise. This has already played out after May this year when $14 billion flew out of Indian bonds, as US treasury yields started inching up. Bank of America Merrill Lynch’s Priya Misra expects US bond yields to rise from the current 2.8 per cent to four per cent by end-2014. Anyway, given the $14 billion, bond markets no longer face the risk of any further sell-off.

Similarly, the currency markets have been firewalled by the Reserve Bank of India (RBI)’s dollar mop-up. Agam Gupta, regional head of Forex and Trading at Standard Chartered Bank, says, “Over the last few months, the RBI has added $20 billion to reserves and companies have bought dollars to hedge their forward dollar payables. Even if there is some sell-off in EM currencies, the volatility will be much lower than before. RBI has ammunition and resolve to manage the rupee on both sides now.” The bank expects the rupee to trade in a broad band of 62-64/$ over the next three to six months.