US markets well-Fed, but India’s?

The cuts have not led to any reduction in problems for the RBI and Sebi

Devendra Nevgi

The US Federal Reserve never disappoints the market, it is said.

The market was expecting a cut of 25 bps in the Federal funds rate and some were even talking about 50 bps.

The power of consensus finally prevailed. The Fed cut the funds rate by 25 bps and the discount rate by a similar margin, its second cut in a matter of 45-odd days.

The tone of the policy statement this time had less to do with subprime/ liquidity related issues and was more about the growth and inflationary risks arising out of higher oil and other commodity prices.

The Fed was back, focusing on its core objective of “price stability and sustainable economic growth.”

It wasn’t as if all the voting members wanted a cut. In fact, Thomas Hoeing, the Kansas Fed governor, preferred no change in the Fed rate.

Hours before the policy meet, the Fed unexpectedly encountered some strong data in the form of better-than-expected Q3 GDP numbers (3.9% annual) validating the fact that US economic growth continue to weather the credit storm.

“Strains in the financial markets have eased somewhat on balance,” the Fed statement said. Is the Fed relatively comfortable with the credit crisis now? It should not, since more is to come from subprime losses, especially from the global banks.

And what did the cuts do to the global markets? Stocks in the US rallied 1%, Asian and emerging markets were up by 1-1.5%.

The dollar breached 1.45 vis-à-vis the euro and 2.08 vis-à-vis the pound, both historical lows. A weaker USD implies that the US consumer will find everything denominated in US dollar and imported into the US expensive.

And a stronger euro would adversely impact the exports of the Euro Zone.

Commodities rallied, including gold, which flirted with $800 per oz, never seen since 1980. Silver and platinum were flying higher, too. That’s the impact of cheaper money on asset prices.

Crude oil flared to $96 p/b more on geopolitical concerns rather than the Fed cuts. The strong US GDP and lower inventory figures though supported it.

From the tone of the US Fed’s statements, it appears that these cuts may be the last amongst the “insurance rate cuts’ driven by the recent “liquidity freeze” in the US financial and money markets, unless the situation deteriorates further.

The subsequent monetary policy (cuts or otherwise) is expected to be more dependent on macro economic variables. Housing and inflation will remain the key inputs.

The US treasury markets witnessed a sharp rise of around 8-12 bps on the 2 and 10-year bonds, post the Fed rate cuts. The probability of a Fed cut implied in futures and options markets in the next meeting was considerably lower.

The last time the Fed effected a surprise cut in the rates, in September, asset prices globally had rallied very strongly, including the risky assets.

Lower interest rates and easy money usually enables global investors to leverage and buy higher yielding and riskier assets.

Indian stock market was the beneficiary of the global largesse of $6-7 billion, which rallied the Sensex to above 20,000 and the Indian rupee appreciated to 39.30 levels.
This time round, it’s different. The Fed rate cut was widely expected.

The Sensex was down 0.57% on Thursday, the day following the rate cut. The Reserve Bank of India (RBI) has clearly expressed its intention to suck out the excess liquidity due to capital flows by using various tools like CRR.

The Securities and Exchange Board of India (Sebi) has restricted FII access to Indian markets through the participatory notes route.

If the US market expectations of a pause in the next meeting turn out to be correct, the global liquidity and risk appetite are likely to reduce.

If this narrows down the funds flow to Indian markets, it can resolve many of the problems faced by RBI on rupee and monetary policy and Sebi on unmanageable and non-transparent capital flows.

The writer is CEO & CIO, Quantum Asset Management Co Pvt Ltd and can be reached at Devendra@QuantumAmc.com. Views are personal.