Vijay Kumar Gaba

UK has allowed the administration of vaccine for SARS-CoV-2 virus (commonly known as Covid-19) developed by Pfizer. Russia and Chinese authorities have also confirmed approval of separate vaccines. In India also couple of developers has expressed confidence that an effective vaccine will soon be available for Indian population.

This is certainly a matter of relief for the distressed mankind living in fear since outbreak of the pandemic. However, for the investors in stock markets wider availability of vaccine could be a matter of slight concern.

So far the investors in equity have had a decent run in 2020, regardless of the severe correction in the early days of the pandemic. In my view, a large part of the price gains in equity stocks could be attributed to the accommodative monetary policy adopted by the central bankers world over.

In past 9 months, a significant part of the cheap and abundant money may have actually flown to the financial assets (mostly equities) as (i) the requirement of money in real businesses have been less; and (ii) the interest rates have persisted at lower levels making it un-remunerative for investors to keep money in short term debt or deposits.

The rising certainty about vaccine availability and subsequent normalization of the accommodative monetary policies may rock the stock market party in 2021. It may be pertinent to recall the impact of taper tantrums on stock markets in 2013, when Fed started to wind up the QE used for supporting and stimulating the economy in the aftermath of global financial crisis in 2008-09.

In a 2017 study, Anusha Chari and others (National Bureau of Economic Research, Cambridge, see here), examined the impact of monetary policy surprises extracted around FOMC meetings on capital flows from the United States to a range of emerging markets. The study revealed “substantial heterogeneity in the monetary policy shock implications for flows versus asset prices, across asset classes, and during across the various policy periods.”, as per the study—

“The most robust finding is that the evolution in overall emerging market debt and equity positions between various policy sub-periods 14 Not reported but available from the authors. 33 appear to be largely driven by U.S. monetary policy induced valuation changes. In nearly every specification, the effect of monetary policy shocks on asset values is larger than that for physical capital flows.

Further, there is an order-of-magnitude difference between the effects of monetary policy on all types of emerging-market portfolio flows between pre-crisis conventional monetary policy period, the QE period and the subsequent tapering period. We detect some significant effects of monetary policy on flows and valuations during the period of unconventional monetary policy (QE). However, the effects are not consistent over all dependent variables. In contrast, during the period following the first mentioning of policy tapering, we uncover a consistent and large effect of monetary policy shocks on nearly all variables of interest.”

Normalization of global trade to pre pandemic levels may essentially obliterate the supply chain bottlenecks and ease commodity inflation. Remember, the pandemic has not caused any physical destruction, as is usually the case with a larger war. Therefore, normalization would not require any major reconstruction or rebuilding endeavor. The damage is mostly to the personal finances and small businesses. This will keep hurting the demand growth for few years and keep the need for additional capacity building low. The new capacities would all be built in healthcare and digital space, not much in the physical space.

In Indian context, in past six months, the yield curve has steepened the most in past two decades at least.

As per media reports, many private companies are able to raise 3month money at 3-3.3%, a rate lower than the policy reverse repo rate as well the corresponding bank fixed deposit rate. Obviously this is an anomalous situation and may not sustain for long.

There is little doubt in my mind that any further steepening of the curve could fuel Nifty to the realm of 15000 in no time. But I have serious doubts whether in a fast normalizing economy, as claimed by various government officials, economists and other experts, the short yields may continue to soften, or even sustain at the current level, especially when the inflation is seen bottoming at or above the RBI target rate.

Any sign of “withdrawal” might shock the brave traders, who are assuming unabated flow of cheap money. Beware!