The much-dreaded tapering of the $120 billion per month bond buying by the central bank of the world’s largest economy has been a running conversation throughout 2021, and an event that has been so well telegraphed by the Fed that it would give some complex to Ben Bernanke under whose watch the infamous “taper tantrum” had occurred in 2013.
To the bemusement of several market watchers, when the US Federal Open Market Committee finally alluded to moderating its asset purchases and bringing it to zero by some time in the summer of 2022 last week, equity investors jumped with joy and most closed higher the following day.
Since Tuesday, though, that joy has evaporated as investors are throwing tantrums over something they did not expect to be a problem at all: a default by the US government.
On Monday, the Republican Party blocked the spending bill tabled by the White House that would have suspended the debt ceiling imposed on the government of the day. The blockage was a move that took the market by surprise, given that it would force the closure of the US government operations from Thursday and will result in a catastrophic default by the US government on some of its debt due mid-October.
While investors have been opiated by the streak of record highs in global and domestic markets aided by strong economic recovery, an accommodative stance of global central banks and free-floating liquidity, Democrats have been struggling to convince the Republicans to allow the debt ceiling to be raised as part of a bipartisan spending bill to boost economic growth.
Republicans have demanded that the debt ceiling be raised as an individual item by the Democrats, who control the US Senate and US House of Representatives as well as the White House.
The move is expected to put the blame of the largesse of the US government squarely on the shoulders of the Biden administration, even though Republican President Donald Trump raised the same debt ceiling several times during his tenure.
The unexpected development has thrown the US government bond market into a tizzy, with the yield on the 10-year Treasury note spiking to 1.54 per cent on Wednesday after hovering near 1.3 per cent last week. Similarly, major US indices such as Nasdaq, S&P500 and Dow Jones saw their biggest single day losses since May.
Reuters on Tuesday reported that JPMorgan Chase & Co has started to prepare for the eventuality of a default by the US federal government; however, it expected policymakers to see the logical step and avoid a “potentially catastrophic event”.
“Every single time this comes up, it gets fixed, but we should never even get this close. I just think this whole thing is mistaken and one day we should just have a bipartisan bill and get rid of the debt ceiling. It’s all politics,” JPMorgan’s CEO Jamie Dimon told Reuters.
A similar squabbling over the debt ceiling under the Barack Obama administration had seen the credit rating of the US government debt downgraded to AA+ by S&P Global Ratings from ‘AAA’, an event that shook global financial markets.
The political drama over the debt ceiling as well as the prospects of lower bond buying by the US Fed will force bond investors to demand higher yield on the US government papers.
Higher yields on the safest investment instrument is bad news for stocks, as it makes future profits less valuable and compresses price-to-earnings multiples. At a time when the Indian equity market is quoting record high PE multiples, for foreign investors Indian equities may not remain attractive enough any more.