US Fed's stimulus cuts may be modest but investors still wary of India

New York: Wall Street closed slightly higher on Tuesday on expectations the Federal Reserve will only make modest cuts to monetary stimulus after a two-day policy meeting.

Though hiring and economic growth in the US remain soft, the Fed is expected to slow the pace of its $85-billion a month in bond purchases as early as Wednesday at the end of its policy meeting.

Most investors expect the Fed’s initial “tapering” move to be small - they expect it to cut its $85 billion monthly purchases of bonds by about $10 billion to $15 billion.

The blue-chip Dow Jones Industrial Average on Tuesday advanced for the 11th time in 14 trading sessions. It rose 34.95 points or 0.23 percent, to 15,529.73.

On Monday, Indian and other Asian stocks got a boost after economist Larry Summers, the frontrunner to head the central bank, bowed out. Summers had long been perceived as an opponent to the Fed’s aggressive bond-buying program, and his withdrawal to succeed current Fed chairman Ben Bernanke had investors predicting that Fed vice-chair Janet Yellen, a supporter of the stimulus program, may be next in line for the top job.

In any case, investors see Yellen and the remaining candidates as being more dovish on US central bank policy, which may slow or reverse the flow of overseas investment out of emerging economies, including India.

Markets were roiled in June after Bernanke for the first time offered a timeline for winding down the Fed’s bond-buying program later this year and end it altogether by mid-2014. That sent a chill through emerging markets. It drew billions back from countries like India, Brazil and China to US assets with investors seeking the relative safety of US equities.

Market swings are possible but some investors dismiss the prospect of as much turbulence this time. They say players in stock, bond and commodity markets have had time to prepare for potential Fed action, assuming the Fed acts largely within market expectations. The US has been talking about tapering going back several months now so global markets sort of think the whole idea of tapering is priced into the market.

“It seems like now the market is believing that tapering will be very well managed by Bernanke, that he knows exactly what the market is expecting and that he’s not going to disappoint,” Jack De Gan, principal and senior adviser at Harbor Advisory told Reuters .

Cautions on India

Over the past couple of weeks, Indian stocks have recovered much of the ground they lost since June. The rupee has also gained around 8 percent since Raghuram Rajan took charge of the Reserve Bank of India (RBI) earlier this month. But despite its recent gains, the rupee at 63.37 to the dollar is still down 14 percent against the dollar since early May.

The RBI will review policy on September 20 after data showed wholesale prices unexpectedly accelerated to a six-month high in August from a year earlier. The Indian market is waiting on both the Fed and RBI decisions.

“Nobody really wants to take a view ahead of the Fed and RBI decisions,” Vivek Chaturvedi, associate vice president for foreign exchange and derivatives at Ratnakar Bank in Mumbai told Bloomberg . “The rupee is in a delicate balance after the recent gains.”

Other investors note that the rupee’s sharp declines in recent months show the country’s vulnerability to foreign money.

“I would not own the Indian stock market,” Jeffrey Gundlach, chief executive of US money-management firm DoubleLine Capital, which manages $56 billion, told The Wall Street Journal , describing the market as “really scary” despite the recent gains.

Capital is fleeing emerging markets as India’s gaping current-account deficit puts grinding pressure on the rupee, China’s economy grows at the slowest pace in 13 years, and persistent inflation in Brazil erodes purchasing power.

“With the US economy on the rebound and flat growth in emerging markets, Western firms expect better returns back home,” said Amrish Shah, who advises clients on mergers and acquisitions at Ernst & Young.

Almost $95 billion was poured into exchange-traded funds of American shares this year, while developing-nation ETFs saw withdrawals of $8.4 billion, according to data compiled by Bloomberg.

Mark Mobius bullish on emerging markets, but not India

Mark Mobius, executive chairman of Templeton Emerging Markets Group thinks Fed tapering fears are overblown.

“This fear of tapering is quite overdone,” Mark Mobius executive chairman of Templeton Emerging Markets Group, told CNBC. Franklin Templeton manages around $834.1 billion.

“What people fail to realize is that the so-called tapering is on top of an incredible increase in money supply in the US,” he said. “These QE programs have been cumulative. It’s not a situation where one stops and all that money goes away,” he said. “It stays in the system.”

“You’re going to see more money going into emerging markets,” Mobius predicted.

But Mobius is less optimistic on the outlook for India. He said he is concerned about the country’s bureaucracy. “They’re just moving too slowly,” he said, adding the barriers to investment are too high. While he still invests in the country, “it’s not at the top of the list.”

Most investors feel India’s weak coalition government has struggled to push through reforms and has no firepower for making structural changes as it faces elections by May 2014.