Hawkish Fed to keep Indian markets on edge

By Ashley Coutinho

Indian equities are likely to remain volatile after the US Federal Reserve delivered a hawkish commentary at the Jackson Hole Economic Policy Symposium 2022 on Friday, belying market expectations that interest rate hikes would taper off over the next few quarters amid the possibility of a peaking of inflation.

“While higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” Powell said in his speech.

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The US market reacted adversely to the speech, with the benchmark Dow Jones registering a 3% drop to 32,283 on Friday.

According to Sonal Desai, chief investment officer, Franklin Templeton Fixed Income, Powell’s speech seems to have given investors some pause. “Markets are beginning to expect a higher terminal rate and to price out some of the rate cuts expected for next year. The market’s adjustment still has a ways to go, in my view. I believe the risk to the June median dot plot peak rate of 3.8% is decidedly to the upside. The adjustment in asset prices will not be smooth,” she said.The hawkish commentary has increased the possibility of a third consecutive rate hike of 75 basis points by the Fed in September.

“The Fed statement appeared to be in favour of further steep hikes for the foreseeable future,” said UR Bhat, co-founder, Alphaniti Fintech. “Given that RBI will try to manage an orderly depreciation of the rupee, interest rate differentials between the domestic and US rates would need to be carefully calibrated and hence the MPC would need to keep hiking rates for some more time. This can negatively impact Indian equities, though the robust Indian economic growth has the potential to attract foreign inflows.”

Indian equities have remained resilient for much of this year despite a pullout by overseas investors. The Nifty Index has rebounded 16.5% since mid-June, while the MSCI India Index has outperformed the MSCI AC Asia Pacific ex-Japan Index by 16.5% since late June. Foreign investors have also returned as net buyers of equities in the past six weeks, buying a net $7.64 billion since mid-July after having sold a net $29.7 billion worth of Indian equities in the first six and a half months of the year.

Foreign brokerage Jefferies remains tactically cautious on the market because of high valuations. The Nifty is trading at 19.3x earnings on a 12-month forward basis.

“The reality is that the Indian market has so far surprised everyone by its resilience in the face of bearish sentiment triggered by the wave of foreign selling, prevailing high valuations and monetary tightening. This resilience should be viewed as reflecting the strength of the structural story,” said Christopher Wood, global head of equity strategy at Jefferies.

“The RBI will most likely take one another rate hike in their next MPC meet, before settling to see the impact on economic indicators. The Indian market has largely discounted this hike by RBI and the Fed,” said Aishvarya Dadheech, fund manager, Ambit Asset Management.

On a positive note, the Fed has been shrinking its balance sheet at a much slower pace than planned keeping liquidity conditions benign. The plan was to reduce the balance sheet by $47 billion per month from June to August and $95 billion every month thereon. From June 1 to August 24, however, the balance sheet has shrunk by $63.6 billion.

“What matters now, more than rate hikes, is the tapering of central banks’ bloated balance sheets. The Fed is tapering its assets at a much slower pace than planned, as it could have severe consequences on economic output,” added Dadheech.

Nifty has formed a small negative candle with long lower shadow on the weekly chart and is expected to trade in 17,800-17,300 zone in the coming week. Auto sales numbers, Reliance Industries AGM, core sector and GDP data will be among the domestic cues in a holiday-truncated week.