Personal Finance

What investors can expect post-Fed comment

Radhika Merwin | Updated on August 04, 2019 Published on August 03, 2019

Financial markets could stay volatile in the coming months

The financial markets have turned extremely volatile after the FOMC’s policy decision on Wednesday. The Federal Reserve reduced the Fed funds rate by 25 basis points, as widely expected. But Fed Chairman Jeremy Powellindicated that there may not be further rate cuts, by stating that this move was akin to “mid-cycle adjustment to policy.”

The markets had been expecting the Fed to launch a rate-cut cycle in August, with three 25 bps cuts by the end of the year. Powell’s comments therefore displeased investors.

What does this mean for equity, debt and currency markets?

Impact on stocks

The Sensex and the Nifty have turned extremely volatile since the FOMC announcement and there is a sharp sell-off in global markets as well.

Equity markets are primarily worried about the impact of the Fed decision to go slow with interest rate cuts, on market liquidity. Foreign portfolio investors have turned net sellers in the equity market since July, pulling out ₹12,419 crore. If the Fed does not continue easing, it will have an impact on the borrowing cost for global investors.

The Fed’s rate hike cycle has already increased the cost of loans taken in dollars, which has been used to buy assets across the globe. As these loans are re-financed, the higher interest could lead to deleveraging or selling of assets purchased with these loans. The other impact of the Fed decision is that the cost of overseas borrowing for Indian companies will increase as they re-finance their overseas loans. The monetary stimulus pumped in by the Fed since 2009 has resulted in the dollar-carry trade accounting for a chunk of the global liquidity pile.

The Indian equity market will try to find a floor in the coming days as investors begin bottom-fishing in stocks that are plumbing new depths. The RBI can provide some succour to markets with a steep rate cut. But with earnings of India inc. not much to write home about, investors need to brace themselves to face volatility for a few more months.

Impact on bond investors

The Indian 10-year government bond yield has fallen sharply by about 60 bps over the past month. The big question is: can bond prices rally further?

Post the Fed cutting rate last week, Indian bond yields have not moved much, mainly due to the Fed dashing hopes of three to four cuts in the coming year. Also, while the Fed action has opened up the possibility of more rate cuts by the RBI, the domestic bond market has already factored in most of the positives.

That said, the joker in the pack is the upcoming RBI’s monetary policy review. Growth concerns on the domestic front have raised expectations of a sharp 50 basis point cut by the RBI. This could lead to some more rally in bond prices (yields can fall further), though concerns over slippages in the fiscal deficit and uncertainty over inflation could limit the upside.

The biggest overhang for Indian bond markets has been the huge gross market borrowings by the Centre pegged at a high ₹7.1 lakh crore in the current fiscal. But given that the borrowing calendar is front-loaded, the market has been factoring in the easing of supply of bonds in the second half of the fiscal.

If the foreign sovereign bond issuance does go through (most reports indicate about ₹70,000 crore), the supply in the domestic market will be even lower.

On the demand front, while PSBs have been net sellers last fiscal and in the current fiscal too, foreign investors have been pumping in money. Currently, the nominal returns on Indian bonds remain attractive at 6.3 per cent.

Even if the RBI cuts repo rate sharply, Indian bond yields will remain attractive, keeping foreign investor interest intact.

On balance, the yield on 10-year G-Secs may remain in the 6.3-6.4 per cent range. A sharp rate cut by the RBI, however, may see yields move lower.

Investors though must temper their expectations and avoid duration and credit risk in their portfolio.

A chunk of debt fund investments should be in short-term debt funds that carry less volatility in returns. Short- and medium duration debt funds with duration of up to three to four years are ideal. Opt for corporate bond funds that invest a chunk of their assets in high-rated debt instruments.

Impact on rupee

The dollar index that tracks the movement of the dollar against six major currencies spiked to 98.6 after the Fed’s statement. The dollar can strengthen in the days ahead as the rates in the US are far more lucrative compared to negative rates of other advanced economies. Further, with the dollar being a safe-haven asset, money tends to move in dollar-denominated assets in times of stress — away from riskier assets. The break above 98 is significant from a medium-term perspective for the dollar. It implies that the greenback can speed towards 103.8, which was the peak formed in January 2017.

The strength in the dollar is likely to have an impact on all currencies, including the rupee. It was relatively stable against the dollar on Thursday, but it has begun sliding rapidly since Friday, moving below 69.6.

If FPIs continue to pull money out of the Indian equity market, that, along with dollar strength, can take the dollar-rupee towards the 70-70.5 zone in the near term. But the relatively attractive real yields on Indian bonds are likely to sustain FPI flows into Indian debt, thus providing support to the rupee, keeping it in the 68-71 range for a while.

While the FPI outflows could continue from equities, inflows are likely in Indian debt due to the relatively attractive real yield. The downward trend in crude prices is also a positive for India’s external trade. In this scenario, the rupee weakness could get limited to the 70.5 level.

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Published on August 03, 2019
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