Fed’s Likely Withdrawal of Economic Stimulus May Hit Stock Markets

Edited by Vani Rao

Liquidity to be tightened following signs of economic recovery

shutterstock_154420583In December 2013, the US Federal Reserve announced that it will start tapering its economic stimulus in January 2014. The Fed had been prolonging this tapering as the signs of economic recovery were not clearly visible. The quantitative easing in the form of bond-buying programs was infusing liquidity into the economy post the 2008 sub-prime crisis. This indirectly helped the stock market revive itself. Of late, the economic indicators like consumer spending and new home sales, excluding labour market reports, have been reflecting signs of an economic recovery. Given this positive scenario, the Fed is likely to announce the tapering of its existing stimulus package. The tapering announcement looks more certain now following the policy-setting meeting of the Federal Reserve on Tuesday and Wednesday.

Effect on Stock Markets

On the domestic front, this situation is expected to trigger a massive sell-off in the week ahead following the tightening of liquidity. This tapering is also likely to hit other emerging economies on the international front as a part of the money from the stimulus was invested in these economies. The investments in the form of FIIs and FDIs came as a saving grace as most these emerging economies have been struggling with their current account deficits. On the other hand, the FIIs and FDIs were reaping the benefits of higher economic growth rate in these emerging markets with cheaper money sourced from the US. Given this scenario, the expected tapering will induce the flight of money back to the homeland as the liquidity takes a hit and will limit avenues to enjoy benefits from these emerging markets.

Buy Time

Even though the tapering announcement will have a negative impact on investor sentiments, it should also be seen as a vital sign of economic revival. Moreover, the air of negative sentiments is only seen to be a temporary phenomenon. The earnings results queued up in the coming days, coupled with the expected fall in stock prices, should make the stock markets more attractive to investors. Given the bearish trend in the stock market, it could be the right time to pick up stocks.

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