An ailing patient already in ICU has been put on ventilator, and the world is celebrating! The ailing patient is the Euro and it is now threatening to spread the contagion affect to other economies of the world. The announcement of QE3 by US Fed chairman Ben Bernanki has sent the world equity markets soaring and Gold-Silver scaling new highs in India. Other commodities including Crude Oil are also in a celebration mood. Taking a cue from Bernanki, Manmohan Singh Govt. has also announced a few reform oriented measures terming them as a 'bold initiative'. No doubt, the markets are celebrating, but is this euphoria justified?
Quantitative
easing (QE)
is an unconventional monetary policy
used by central banks to
stimulate the national economy when conventional monetary policy has become
ineffective. A central bank implements quantitative easing by buying financial assets from commercial
banks and other private institutions with newly created money, in order to inject a
pre-determined quantity of money into the economy. Following the stimulus measures announced by Draghi of ECB, it is the third time the Fed has gone to extreme measures to inflate
the money supply, and thereby increase economic activity. The Fed announced its plans to buy up to $40 billion worth of mortgage
bonds each month from now until the end of the year.
Quantitative
easing may cause higher inflation than desired if the amount of easing required
is overestimated, and too much money is created. If QE3 misfires US could slip into a zero growth territory as Japan suffered in the past decade due to deflation. QE3 has the potential to disturb the apple cart of economies like India who import 70% of their oil requirement. Oil prices and other commodity prices are likely to zoom as the excess money printed by central banks finds its way into the commodity markets. One asset class that is sure get benefited will be the precious metals like Gold and Silver which may touch their lifetime highs by the end of the year, as US $ comes under pressure. The Indian Rupee should show some strength but its upward movement against the dollar would be capped by the huge fiscal deficit which is likely to be around 6% of GDP.
The stock markets which are showing strength are ignoring the negative impact of QE3 as discussed above. Investors should take this opportunity to book some profit around 5700-5800 on Nifty, as the markets would start correcting soon as the perception of traders undergoes a change once they do the reality check. The reform measures announced by the Govt. will also face much criticism from the opposition and some of them may have to be rolled back or put on hold. The euphoria in the equity markets does not stand merit given the fragile nature of Euro zone, which will have a negative impact on Indian economy in the short term. Equity investors need to adopt a cautious approach, albeit investment in gold would be a smart choice at this juncture.
