The US dollar rose to four-month highs against the euro Tuesday after two Fed officials Monday said the US economy is growing rapidly. While the labour market has room for improvement, inflation is already at a level that could satisfy one leg of a key test for the beginning of interest rate hikes, Reuters reported.

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On the other hand, Shankar Sharma, MD of First Global believes Federal Reserve cannot afford to raise rates now, as there is a lot of headroom for a rally in the equity markets globally.

“Short point is interest rates are the fulcrum around which equity market valuations revolve. The Fed has painted itself into a corner over the last 11 years since the global financial crisis of 2007-08. It has found a good way to make people forget the pain of the real economy by giving them this shooting balm of low interest rates. It pumps up asset prices, so real estate also goes up,” Sharma said.

The United States and several other economies, including Japan, have been keeping interest rates near zero to stimulate economies in the years following the Great Recession of the late 2000s. This spurs economic activity by encouraging low-cost borrowing and access to cheap capital.

“So that gives people a sense of security and then when the stock market rallies, again give them a sense of security. This cushions the blow of the real economy, the real pain of businesses,” he said.

Sharma doesn’t see this unwinding anytime soon.

“Why on earth or how on earth can the Fed unwind? It will end up hurting the stock market, end up hurting this asset bubble. So, we are in an era in which the Fed will bend over backwards to keep rates low, it simply cannot afford to raise it,” the market veteran said added.

Federal Reserve has kept interest near-zero since the breakout of the coronavirus pandemic. Since then, it has kept its monetary policy accommodative to let the economy recover from the throes of the outbreak. Now it is talking about talking about hiking the interest rates.

Atlanta Fed President Raphael Bostic said he is eyeing the fourth quarter for the start of a bond-purchase taper. But he also said he is open to an even earlier start “if the job market keeps up its recent torrid pace of improvement”.

However, Sharma believes this is nonsense.

“So, markets figure out this blackmail, that you will raise rates, they will crash 10-15 percent, you will be forced to unwind your policy. So, I have no faith in the Fed’s 2022-2023 forecast that we will unwind and all that. This is all nonsense in my view. I think you will remain at easy levels. Inflation can be easily managed; they are managing it they will manage it,” he said.

“With that backdrop, I think the lake of return theory coming back to tell me there is still a lot of headroom available for equities to go up globally.”

According to the Lake of Returns Theory, each asset class has a finite amount of return potential based on its long-term return characteristics. It is like the capacity of a lake. It can only hold a finite amount of water.

So when the levels of returns in any asset reach extremely low levels as compared to its long-term returns, that’s when it is time for the lake to start filling up. And when the returns (or water levels) overflow, the asset class overshoots its long-term trend. That’s when the markets flood and cause devastation through a bear market.

Also Read: Expect some correction but not as much as a bearcap scenario: Shankar Sharma

For full interview, watch the accompanying video...

(Edited by : Yashi Gupta)

First Published:Aug 10, 2021 3:41 PM IST