Fed rate hike signal may derail Indian market rally

On Thursday, Indian markets extended weakness for a second straight day. The BSE Sensex slipped 178.65 points or 0.34% ending at 52,323.33. The Nifty was down 76.15 points or 0.48% at 15,691.40. Among shares in Asia-Pacific, Nikkei in Japan fell 0.93% while South Korea’s Kospi closed 0.42% lower.

“Weak global cues along with weekly F&O expiry led to a volatile session. Metals continued to witness selling pressure after China announced intentions to release industrial metals from its national reserves to restrain commodity prices,” said Motilal Oswal in a note.

Federal Reserve officials held interest rates near zero but signalled that it might raise interest rates at a much faster pace than assumed, sending yields and the dollar sharply higher. Indicating that broad changes in policy may happen sooner than expected, US central bank officials moved their first projected rate increases from 2024 into 2023. The Fed policy statement marked a strong vote of confidence that the U.S. recovery is on track.

Going forward, India and other emerging markets may face some pressure as they can be vulnerable to the chance of early US rate hikes to contain inflation, which could result in foreign investors pulling out of riskier assets, said experts. To be sure, an actual rate hike, even if the Fed has brought forward the timeline to 2023, still remains some time away, thus the impact of Wednesday’s policy statement may be limited in the near term.

FIIs have pumped in $8 billion in Indian equities so far in 2021 while benchmark indices have been hitting fresh record highs.

Vinod Nair, Head of Research, Geojit Financial Services said, “While the fast normalization of the economy and strong job market can lead to a taper in bond-buying plan. This can lead to tightening of bond yields which will impact the pricing of equity asset.”

Typically, higher interest rates in the US tempt large foreign funds to move their money to the US, hurting emerging markets including India. Exit of long-term money may be concerning as markets rely on foreign fund flows for liquidity. In the month of June so far, FIIs were net buyers of Indian shares worth $1.63 billion, being net sellers only in April when they dumped $1.48 billion worth of shares.

Others feel that domestic institutional flows are strong enough to support the market in the absence of liquidity from FIIs.

“In the short term, Fed rate action may impact negatively if the dollar index crosses the levels of $92. However, the current rally or current inflation is demand pulled and at major levels, value pickers would enter with a long term view. In the short term, we might see some correction but in the long run, we are expecting flows due to expectations of a good monsoon, a rise in the GST collection and consistency in the reform process,” said Shrikant Chouhan, Executive Vice President, Equity Technical Research, Kotak Securities,

So far, Indian markets have outperformed emerging markets with the benchmark index Nifty rising 11% while MSCI Emerging Markets index gained 6%. MSCI World, which represents large and mid-cap equity performance across all 23 developed markets, has climbed 12% in 2021 so far.

“High liquidity and low interest rates have led to inflows of equities in Emerging markets such as India…India’s valuation premium with respect to MSCI Emerging markets has remained stable at 40-45% over the last year indicating that the rally has been a global one,” said Tata Mutual Fund.

Meanwhile, the Indian rupee weakened against the US dollar on Thursday, amid the strengthening of the greenback in the overseas market. The domestic currency closed at 74.08 a dollar, down 1.02% from Wednesday’s close of 73.33, a level seen on 30 April. The yield on 10-year government security rose to 6.06% intraday compared to 6.04% at close on Wednesday.

“Rupee fell sharply in today’s session after the Federal Reserve released its policy statement, wherein it held rates unchanged but turned a little hawkish in its commentary. We expect the USDINR (Spot) to trade with a positive bias and quote in the range of 73.70 and 74.30,”Gaurang Somaiyaa, Forex & Bullion Analyst, Motilal Oswal Financial Services said.