Big Ben effect: Sensex, Nifty, rupee all seen higher today

The US Federal Reserve, in its last Federal Open Market Committee (FOMC) meet for calendar year 2013, clearly laid out a road map for taper of asset purchases. The Fed also lowered projections for the US unemployment rate to 6.3% for end 2014 as compared to initial estimates of 6.4% to 6.8%. The Fed’s statement on taper, rates and unemployment drove the benchmark US equity index the Dow to record highs.

The Sensex and Nifty will benefit hugely from the Fed’s policy of a calibrated taper of asset purchases as will the Indian rupee. The fact that the RBI refrained from raising the repo rate in its policy review yesterday will add strength to the markets. It is well likely that the Indian benchmark stock indices will go into 2014 on a bullish note and the rupee will strengthen against the dollar. The Sensex and Nifty at 20,883 and 6,228 levels, respectively, are trading 2% off record highs while the rupee is up 10 percent from lows at Rs 62 to the dollar.

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The Fed cut bond purchases by $10 billion from $85 billion to $75 billion in its December 2013 meet and indicated that it will reduce asset purchases in every meet going forward. The Fed maintained that interest rates will stay at close to 0 percent until the unemployment rate drops below 6.5% and inflation expectations rise to over 2%. The Fed is looking at interest rates starting to move up in 2015.

The Fed will watch data for calibrating its taper. Strong data will increase the amount of taper while weak data will prompt the Fed to skip taper in its policy meet. US economy is showing signs of strength with unemployment falling to five-year lows of 7%, the housing market improving given low interest rates, improving employment prospects, real estate becoming more affordable, rising consumer confidence and improving retail sales data. US equities are at record highs and with house prices rising, the wealth effect is kicking in.

A shale oil revolution that has seen its oil imports falling 11 percent year on year in 2013 and the country producing more oil than it imports, the first time since 1996, help the US. Plentiful oil and gas has kept fuel prices low and this is helping manufacturing industries with many US companies starting to relocate back to the US from other so-called cheap production countries.

The Fed’s stance of an easy monetary policy coupled with a strengthening economy is positive for the US and global equities. Equity markets in the US, Germany, UK, Japan and India are at record highs or close. The strong equity run will continue into 2014. The calibrated taper will help emerging market currencies that saw a selloff during May-August when talks of a taper emerged first. The rupee had touched record lows against the dollar in August but has since then strengthened by 10%.

The bond market’s reaction to the Fed policy will be positive, as the RBI will have more flexibility on its monetary policy given rupee’s stability. Government bond yields reacted positively to a status quo on rate hikes by the RBI with yields falling by 10bps to 13bps across the curve. Bond yields will continue on its downward trend on the back of expectations of FII flows into Indian bonds given the expected stability in the rupee and the high interest rate differential of 6% between the US and Indian 10-year bonds.

Arjun Parthasarathy is founder Investors are Idiots.com and INRBONDS.com. Follow him on twitter #arjunparthasara