DId the Market Overreact to Fed’s QE exit plan ??

Fed Jitters ….

The phrase Quantitative Easing (QE) is back in vogue . Pundits are back  pumping predictions   on QE fallout . For the uninitiated , QE refers to Fed’s printing money ( by purchasing bonds)  to pump global liquidity as a monetary stimulus for struggling economy . It works by keeping long-term rates low . This is  besides its already exhausted short-term interest rate setting tool ( Fed rates which are already near zero)  . The mere prospect of Fed slowing down bond purchases (phased exit of QE ) at a distant future , that too subject to certain evolving data points ( unemployment numbers in particular) , has rattled bond , currency and equity markets across emerging markets to a point that can at best be  termed “insane” , if not anything more neurotic . Firming yields , tanking currencies , sliding equities across emerging markets in a pro-cyclical fashion ( one leading to another in self-fuelling  loop) conjure up as a fascinating   global financial cosmic dance with  nothing to support at the core  .

Fed’s signals are fuzzy in its own admission . Its plan for slowing down QE and its eventual exit is tied to many “ifs and buts” that it does not suggest any immediate tapering . In any case , complete exit is not anytime soon , even by its own hawkish tone .  

 

What then  underscores such a violent response in emerging markets across asset classes to  the Fed’s press conference last week on QE . On digging  deeper , one can see the  devious designs behind the jitters .  

Global fund managers play to the theme in unison . It ( consensus theme / trade ) usually plays out over six to twelve months if not more depending on how raging  the animal spirits are . The consensus trade over last year+ has been to borrow dollars to invest in shaky emerging market assets . With Fed pumping unlimited liquidity ( thro QE) , this dollar carry trade ( if one may call so J ) worked wonders for the fund managers . This easy money kept the emerging markets currency artificially high , yields low and equity prices elevated . Countries like India funded its alarmingly high CAD (current account deficit) with this ample dollar liquidity without any major damage to its currency till last month , though honeymoon did not last longer .

Any such consensus trade has a fixed shelf life , so is this dollar carry trade . It has to unwind at some point . The catalyst ( rather excuse) for such unwinding usually comes from many forms , not limited to only rational ones . The proverbial last straw for the present case came from Fed noise on QE . Nothing more and nothing less . The unwinding is never smooth and often depressingly painful , so are the current jitters in the financial markets across emerging markets .

The relief is , once readjustment process is done , fund managers will invent another theme for the play for the next season . No surprise that the Yen carry trade is yearning for attention and will soon fit into the script given the ample bazooka (liquidity) which Abenomics is throwing into markets . Wise investors understand this and capitalize  this chaotic cosmic dance by buying into distressed assets . Panic is the last thing they succumb to . What else would otherwise explain the ironic movement in Rupee . The currency that was showing strength all the while when our current account was bleeding with heightened gold imports , has started sliding to new low just when the macro is turning for the better with Gold turning into a bear market and Brent crude spread falling to all time low (the difference in price between Nymex and Brent falling to less than 7 $ ). Not to leave behind the moderating inflation and the impending benefit of base effect . That much for fundamentals in financial markets .    

This is yet another instance of market’s vicious  slide in the series of deep cracks in a gradually improving macro , which value investors should wisely exploit to reap the rewards on the eventual big turn , timing of which is still unknown though .

Happy Value Investing !!!

ArunaGiri . N

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