Central bankers drive stock markets. At least, that is the way things have been since the current financial crisis started in September 2008, when Lehman Brothers, the fourth largest investment bank on Wall Street went bust.
On March 30, 2016, the BSE Sensex rallied by 438 points or 1.8% to close at 25,338.58 points. What or rather “who” was responsible for this rally? Janet Yellen, the chairperson of the Federal Reserve of the United States, the American central bank.
Yellen gave a speech on March 29. In her speech she said: “I consider it appropriate for the committee to proceed cautiously in adjusting policy.” The committee Yellen was referring to the Federal Open Market Committee or the FOMC.
The FOMC decides on the federal funds rate. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.
In December 2015, the FOMC had raised the federal funds rate for the first time since 2006. The FOMC raised the federal funds rate by 25 basis points (one basis point is one hundredth of a percentage) to be in the range of 0.25-0.5%. Earlier, the federal funds rate had moved in the range of 0-0.25%, for close to a decade. FOMC is a committee within the Federal Reserve which runs the monetary policy of the United States.
The question that everybody in the global financial markets is asking is when will the FOMC raise the federal funds rate, again? It did not do so when it met on March 15-16, earlier this month. The next meeting of the FOMC is scheduled for April 26-27, next month.
By saying what Yellen did in her speech she has essentially ruled out any chances of the FOMC hiking the federal funds rate in April 2016. This is the closest a central bank head can come to saying that she will not raise interest rates any time soon.
This was cheered by the stock markets all over the world. Yellen basically announced that the era of “easy money” was likely to continue, at least for some time more.
This means that financial institutions can continue to borrow money in dollars at low interest rates and invest this money in stock markets and financial markets all around the world, in the hope of earning a higher return.
The “tourist dollars” are likely to continue to be invested into the Indian stock market. Mohamed A El-Erian defines the term tourist dollar in his new book The Only Game in Town. As he writes: “During periods of large capital flows induced by a combination of sluggish advances economies, robust risk appetites, and highly stimulative central bank policies, emerging markets serve as destination for a huge pool of crossover funds, or what I refer to as tourist dollars.”
As Erian further writes: “Rather than “pulled” by a relatively deep understanding of country fundamentals, this type of capital is typically “pushed” there by prospects of low returns in their more traditional habitats in the advanced world.”
The federal funds rate in the United States is in the range of 0.25-0.5%. In large parts of Europe as well as in Japan, interest rates are in negative territory. In this scenario, the returns available in these countries are very low. At the same time, it makes tremendous sense for financial institutions to borrow money at low interest rates from large parts of the developed world and invest it in stock markets, where they expect to make some money.
And India is one such market, where these “tourist dollars” are coming in and will continue to come in, if the central banks of the developed world continue running an easy money policy.
What got the stock market wallahs all over the world further excited was something else that Yellen said during the course of her speech. As she said: “Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long term interest rates and so support the economy.”
What does this mean? This basically means that, if required, the Federal Reserve will print money and pump it into the financial system to drive down long-term interest rates in the United States, so that people will borrow and spend more. This was the strategy that the Federal Reserve used when the financial crisis started in September 2008. This basically means that the era of easy money unleashed by the Federal Reserve is likely to continue in the days to come.
Now only if the Modi government could get its act right on the economic front., the tourist dollars would just flood in.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
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Updated Date: Mar 31, 2016 07:31:19 IST