Shares, gold, silver plunge after Fed makes a statement

Shares, gold, silver plunge after Fed makes a statement


Since May 21, when Ben Bernanke, the US Federal Reserve chief, hinted at withdrawing Quantitative Easing, to Thursday, a day after he hinted again, world equities have lost $2.4 trillion in value.
That’s perhaps the biggest loss a few words have caused to investors worldwide.

Be that as it may, Thursday was the scene of a bloodbath in all asset classes after Bernanke said the Fed might moderate its bond purchases by this year end and end them around mid-2014, if US unemployment falls to 6.5% and other economic indicators are achieved.
While global equity markets dropped 2-3% on heavy volumes, gold and silver too tanked nearly 5% and 8%, respectively.

The Indian equity markets were ravaged, losing 2.74% and erasing Rs 1.57 lakh crore of notional investor wealth.

Investors have now lost Rs 5.70 lakh crore in the past 23 trading sessions, since May 17, 2013, when the Sensex touched its recent high of 20286.12.

Tries to answer some questions that might be on your mind:

Why did all asset classes, shares, gold, bonds, fall?
Even though there was nothing new in the Fed’s statement, Bernanke’s hawkish tone fuelled fears the Fed might ‘taper’ (or reduce bond purchases) earlier than expected, which could squeeze out liquidity that has rushed into different asset classes after the QE began.

Why is there so much weakness in the rupee?
It’s because there is no interest rate arbitrage in Indian bonds. So FIIs have been unloading sovereign bonds, just like everywhere else in the emerging markets.
They had played the ‘carry trade’ where they borrowed dollars at cheap rates and invested in high-yielding emerging market bonds. But with emerging market currencies turning highly volatile due to global liquidity fears, FIIs’ cost of hedging (carry trades are hedged to save investors from currency swings) has soared.
With yields also not helpful, carry trade in bonds is no longer profitable. Also, with the US economy growing, money is shifting to that country. Thus with FIIs demanding dollars to take back to the US, and the US dollar rising globally, the rupee has received a double blow.

But why has gold fallen?
Gold is normally considered a safe haven and so typically attracts money when people are uncertain about future growth and macro environment. With growth in the US seen recovering and no major risk of an immediate crisis in Europe, people are now dumping gold in favour of shares of developed-market companies that could benefit more.

What happens to equities now?
Equity markets in India are likely to remain volatile because of macro issues such as high current account deficit, delay in revival of investment cycle, political uncertainty going into elections and, above all, high dependence on capital flows. Equities are unlikely to see a crisis-like selloff, but the upside looks limited in the near term.

What about the rupee?
The rupee is likely to remain weak because of India’s high current account deficit and until the government takes further reform measures to tackle the structural problems, including of inflation, the currency would be dependent on the direction of foreign flows.