Markets: A taper test for 'the rest'

The start of the US Federal Reserve’s stimulus policy had dramatic spill over effects for emerging markets, like India and Brazil, and the same is proving true of its withdrawal.

The volatility across emerging markets, including both currencies and equities, is a direct reflection of the distortions created by quantitative easing. Sudden and dramatic asset price fluctuations are making investors scrutinise the unintended side effects of the US central bank’s costly policy.

Unfortunately for emerging markets, with India and Brazil already taking the brunt of adverse consequences, it looks like capital flows will continue to be volatile, disrupting exchange rates and making inflation difficult to manage.

Consequently, the divergence between developed and emerging markets is becoming more pronounced and is increasingly important for Australia.

India’s sliding currency means they will have less purchasing power for imports, including Australian goods. Since May highs, the rupee has slumped 20 per cent against the US dollar to a record low.

Spiros Papadopoulos, National Australia Bank senior economist, notes anything that impacts the growth of our key trading partners such as India and China is going to impact us, directly or indirectly.

For emerging markets, inflation remains a real threat, especially since food and commodity prices generally constitute a much higher percentage of GDP than in developed markets.

Domestically, everyone is tangled up in taper talk. It is a foregone conclusion it is happening, the questions remains when? How much from Treasuries? How much from mortgage-backed securities? Be aware, the Federal Reserve will do what benefits the US economy and financial markets. As investors, we need to be aware of the implications beyond US shores.

India is our fourth largest export destination and the US is fifth. We need India to make the necessary structural changes to recover from the current difficulties they are facing.

The latest figures show that US GDP grew at an above-trend 2.5 per cent in the June quarter, much higher than 1.7 per cent originally reported. Recent better-than-expected economic conditions suggest tapering is all but confirmed by officials. But if US payroll data for August due out next Friday is below expectations, it could delay the start of any tapering program.

Much of the impact of tapering is already priced in, with the US dollar strengthening against most major trading partners. The long-term US bond yield has surged 1.32 per cent since May to touch 2.93 per cent last week.

Equity markets are yet to come to terms with taper talk. Until the next Federal Open Markets Committee meeting in September or any Freudian slips from Fed members, equity markets are going to remain uncertain.