What the Fed meeting minutes mean for India

FOMC minutes had little by way of a firmer indication whether tapering of stimulus would start in September.

Here are the references to emerging markets in the much-awaited the Federal Open Market Committee (FOMC) minutes of the 30-31 July, out last night. They say, “A slower pace of expansion in many emerging market economies (EMEs), including China, since the beginning of the year offset an increase in the average rate of economic growth in the advanced foreign economies.”

On currencies, the minutes say, “The foreign exchange value of the dollar was little changed, on average, relative to the currencies of the advanced foreign economies, but appreciated against EME currencies amid weak incoming data on economic activity and monetary policy easing in some EMEs,along with rising US treasury yields. Emerging market mutual funds experienced sharp outflows in recent weeks, while EME stock prices declined and EME credit spreads widened on net.”

The committee members also “pointed to the foreign economic outlook as an ongoing downside risk”. The change in the economic outlook for emerging and developed markets has led to money flowing out of emerging markets, hurting their currency, bond and equity markets.

The FOMC minutes had little by way of a firmer indication whether tapering of asset purchases would commence in September. All it showed was that members were comfortable with tapering later this year.

But what matters was the reaction to the minutes. After an initial sell-off, US stocks and bonds snapped back, but settled lower at the end of the trading day. The US dollar strengthened. A jump in existing home sales added to the chances that the tapering would start next month. The Fed chairman has emphasized the timing of the taper depends on the data, but that has been mixed so far.

For emerging markets, the fundamentals are going wrong. At a time when the purchasing managers’ indices (PMIs) for the US and UK signal expansion, the HSBC emerging markets index for July fell to 49.4, indicating a contraction from the previous month and a new post-crisis low. The HSBC India Composite Output index for July showed that private sector output contracted for the first time since April 2009.

All emerging markets have been hit and the Brazilian currency market, which must have taken the FOMC minutes into account, saw a 2.5% sell-off on Wednesday, while its Bovespa stock index fell 0.2%. The rise in US bond yields after the disclosure of the FOMC minutes point to a continuation of fund flows out of emerging markets and a continuation of recent weakness in their currencies and equities.

This morning, the China HSBC flash manufacturing PMI came in at 50.1, a four-month high and indicating a slight expansion. That is likely to support Chinese equities, which have rebounded in the past few weeks. But the Chinese and Indian markets have moved in opposite directions recently.