If Sensex, Nifty crack blame it on US Fed and not RBI policy. Here's why

By VK SharmaHDFC securities

While the US market closed with modest losses on Wednesday, they hide the impact they could have on international markets.

Sending the indices tumbling from their intraday gains were the minutes of the March FOMC meeting that showed that the Fed plans to begin unwinding its USD 4.5 trillion balance sheet later this year.

The implications of this could be hugely negative for the global markets.

What this means is that the Fed will start sucking back all the stimulus it has given to the markets all these years.

Consider what it entails:

1.The Fed will need to sell the bonds it has purchased. That means with this supply, the bond prices should fall, sending yields higher.

2.The dollar could also strengthen, as the Fed reduces the dollar in circulation. Both the events are negative for the global markets, leave alone emerging markets.

While on the one hand, the Fed decided to sell bonds is a sign of the confidence for the US economy, its actual deleveraging could send the markets into a cash crunch.

We believe that the Fed has acted too prematurely. We say this because:

1. The Trump regime has not been able to come out with a viable health proposal, after its failed attempt to pass the health bill.

2. Trump has still not thrown any further light on his promised tax breaks

3. With so much of an uncertainty, where was the need to further muddle the waters by throwing in this spanner of balance sheet contraction?

Now let’s look at the Bond and the currency markets.

The bonds should have sold off and greenback should have appreciated.

But, we see the following:

1. The yield on the 10 years has fallen. The ten-year bond closed with a yield of 2.334%, down 0.030 from 2.364 %.

2. The Dollar has depreciated. The Dollar Index closed at 100.35, down 0.01 from 100.36.

We believe that the bond markets are more mature, sensible and logical than the equity markets.

So the conclusion that we draw is that though the Fed may have plans to contract its balance sheet, it may not do so in the near future.

We believe that the Fed’s talk of a balance sheet contraction, even before all the planned hikes have gone through this year, is to bring the markets down to terra firma, rather than any genuine desire to do so at this juncture.

While there could be many a proverbial a slip between the Fed Cup and the lip, this one could seriously dent the global sentiment, especially when Trump has still not unveiled policy measures to boost economy and state spending on infrastructure.

The final element of Trump’s policy, US protectionism, will be at test today and tomorrow, as he interacts with the visiting Chinese President Xi Jinping. Our own Central Bank Policy that comes out on Thursday, could see some negative impact of these latest FOMC minutes.

We would rather take some profit off the table at this juncture, then skate on thin ice.

Disclaimer: The author is Head - Private Client Group, HDFC securities. The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.