Central banks gear up for tapering; expect movement in equities, other assets may remain contained

October 15, 2021 3:36 PM

The word ‘Tapering’ if anything, in the last decade, has long ceased to be a verb. Many by now would have personified it to be an evil-looking demon.

Factors of global commodity price rise however have a far muted impact owing to their relatively insignificant presence in the relevant indices of WPI and CPI. (Image: REUTERS)

By Lakshmanan V

The word ‘Tapering’ if anything, in the last decade, has long ceased to be a verb. Many by now would have personified it to be an evil-looking demon. However, if we were to see the initial outcomes post the Fed announcement, the markets have taken the latest communication on the onset of this demon in its stride. The stock markets have remained largely placid so far.

A large credit for this semblance of calm, in an otherwise highly feared market phenomenon has to be given to the Community of Regulators across geographies. An exceptional balance of expectations setting with a high degree of precision in market actions appears to have been the recipe for this.

Having said so, we are still in the midst of the episode and the verdict is still far from out. Where do we go from here? A recap of the key variables and what they imply is stated below.

Higher US Inflation readings are widely believed to be transient. However, a key contributor to the US inflation, Used cars, is unlikely to ease as New Cars may be off the roads for a long time. The key impediments of chip shortages are far from getting resolved anytime soon. Inflation Expectations readings too have moved higher, implying commoners are still not buying the transient story of Inflation.

Industrial Commodities for varied reasons have been trading at close to highs. Aluminium prices are trading at highs last seen in 2008. A similar story goes for steel. Other commodities like Copper, Tin and many others display a similar story. To add to the raw material cost, the shipping industry crisis and the Container shortage adds a lot to the woes of the Producers.

Producer Price Inflation readings of various Geographies – Eurozone, Japan, China and many more – have all recorded significant increases. Almost in all cases, the producers have refrained from passing the price increases to Consumers, thus far. But for how much longer? In summary, the upside threat to Consumer inflation is real. This has not yet factored demand-led price increases which will hopefully set in once the latest wave of COVID settles down . The US Fed in its policy statement has potentially seen through this risk and thus guided on the need for tapering soon.

Factors of global commodity price rise however have a far muted impact owing to their relatively insignificant presence in the relevant indices of WPI and CPI. Domestic inflation factors, driven predominantly by domestic cost factors of food and consumption products needs to be viewed. Food inflation, supported by optimal Monsoons and resultant advancement in Kharif sowing, policy interventions for consumption items bode well. Fuel inflation, with limited ability to exercise control, will be driven by Global vagaries of Oil production and consumption. Core Consumer Inflation has stayed largely reined in, but stands most at risk owing to WPI upticks. Overall CPI at the moment appears to be treading in a fine balance.

Add to the above, the healthy expectations for the performance of the country on the fiscal side. Further the added conversations on the inclusion of the Indian bond in Global Indices. This potentially lends a good balance to the bond market in the near term.

Equity markets have looked rich for a long time now and the EM equities could be potentially at risk owing to tapering. Having said so, the Indian equities, even if they correct temporarily, are likely to be supported well in the near term by the promises on Asset Monetisation, IBC, China concern, recent display of pragmatism by the Government in resolving long pending stalemates. On the forex side, while INR will see the risk of depreciation, the Forex Reserves and their might add a huge comfort.

Overall, except for equities which may see some movement, the rest of the markets are likely to remain contained. Volatility hawks need to hold more patience.

(Lakshmanan V is the SVP and Head Treasury of  Federal Bank. Views expressed are the author’s own. Please consult your financial advisor before investing)

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