Fed unlikely to taper off asset purchase before early 2014

In a perverse manner, US political deadlock is feeding into better times for emerging markets including Indian markets.

The current stand off in the US with the Congress unable to pass the budget for this fiscal year has placed most of the functions of the US government on a standstill. Estimates are that the US economy is seeing losses of $300 million a day due to the government shut down. The US economy is close to 10 days into the shutdown and the debt ceiling limit is yet to be raised, raising questions of US default on its obligations. The latter has wide spread repercussions all over the world as foreign holdings account for 48 percent of US debt.

US Federal Reserve chairman Ben Bernanke. Getty Images

US Federal Reserve chairman Ben Bernanke. Getty Images

The US budget impasse was highly avoidable but the fact is that is has happened and the US economy will have to live with the consequences. The US economy, while showing signs of recovery with monthly job additions, unemployment rate coming off, housing sector looking up and retail sales and consumer confidence rising, has received a jolt due to the shut down of the government.

The fact that mortgage rates have risen by around 100bps from lows on the back of rising US treasury yields that rose 150bps from lows over the last couple of years has raised questions on the sustainability of a recover in the housing sector. The housing market in the US slumped in 2007-08 post the mortgage bubble burst and has been showing signs of recovery with prices and new home sales rising to multi year highs.

The US Federal Reserve (Fed) was on the verge of tapering off its $85 billion a month asset purchase program in September but held back on worries of higher mortgage rates and on potential effects of a deadlock in Washington. In hindsight the Fed's move proved right as the US economy could take a knock going forward. The Fed had lowered US GDP growth rates by 300bps to 400bps from 2013-14 (upper end of a range) as it saw job growth being slower than expected.

The Fed is likely to get a new chairman in January 2014 as Ben Bernanke term comes to an end. His replacement is expected to be Janet Yellen who is currently the Fed's vice chair. Ben is likely to put off tapering to the new chairman as indicators from inflation to unemployment rate is below and above Fed's target range respectively. Core CPI (Consumer Price Inflation) printed at 1.8 percent in August, below Fed's target rate of 2 percent while Unemployment rate was 7.3 percent in August, above Fed's comfort levels of 6.5 percent.

The Fed can afford to wait for a few more months to start tapering down its asset purchase programme. The postponement of the tapering is positive for markets that had sold off sharply on expectations of Fed's asset purchases slowing down from September 2013. Emerging markets were the worst hit with equities, currencies and bond prices falling sharply from India to Indonesia. The INR touched all time lows against the dollar in August 2013 while 10 year benchmark bond yields rose close to 200bps from lows seen in May 2013 as FII's pulled out money from Indian markets on fear of liquidity withdrawal by the Fed.

The INR has strengthened by around 10 percent from lows and ten year bond yields are off by 50bps from highs over the last couple of months. RBI has started to reverse its liquidity tightening policies that were implemented to prevent INR volatility. RBI has brought down the MSF (Marginal Standing Facility) rate by 125bps over the last fortnight and is infusing money into the system through bond purchases and term repos. RBI is likely to go back to its normal mode with growth-inflation trade off being policy objectives rather than preventing INR volatility as its primary policy objective.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a website for investors.

Updated Date: Dec 21, 2014 00:39 AM

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