How Jerome Powell’s speech will impact Indian markets
Premium- Global traders see tightening stance simply in terms of more expensive money and less liquidity, which leads to what is called a “risk-off” situation.
The traders’ response to Federal Reserve Chairman Jerome Powell’s recent speech at Jackson Hole was predictable, if knee-jerk. The response of other large central banks may be more nuanced, but it is likely to be just as predictable.
In his speech, Powell clearly signalled he will do what it takes to crush inflation. That involves raising the so-called Fed Funds rates by at least another 75 basis points in late September, when the FOMC meets again, and it implies the threat of raising the rates again if the FOMC deems it necessary.
This is an unpleasant surprise for traders since there had been talk about possible moderation in inflationary expectations, and the hopes of a “soft landing". Moreover, the hawkish monetary stance of the Fed is going to be backed with a tighter stance by the ECB, which is likely to follow through with a rate hike of its own in early September, going by the messaging from several ECB board members who were also present as speakers at Jackson Hole.
Both the Fed and the ECB hiked rates in their last monetary policy reviews so this carries through an established trend. Almost inevitably, it means bond yields will rise across Eurozone and the US. It also means the USD is likely to appreciate against most other currencies, and the Euro could also harden versus non-USD currencies.
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Global traders see this situation simply in terms of more expensive money and less liquidity, which leads to what is called a “risk-off" situation. Hence FPIs will cut exposure to more risky assets. That means a retreat from emerging markets assets (even EMs with convertible currencies). It means a reduction in exposure even to hard-currency equities, and a move from more speculative debt to government bonds and US treasuries.
Industrial commodities may also see corrections. This is partly a statistical quirk because most commodity prices are reported in USD and a strong dollar automatically means lower commodity prices. But industrial metals had started losing ground a while ago, due to fears of slowdowns in global growth and consequentially weaker demand.
Energy prices could also fall for the same reasons. The Indian crude basket (which is a combination of Oman Sours and Brent Sweet) cost $116/barrel in June and $97/barrel in August as global demand weakened, and fears of supply disruptions caused by the Ukraine War eased. Further falls in crude prices could be a silver lining for India, which imports 85 per cent of its oil.
We’ve seen some impact with Wall Street’s Dow Jones IA dropping 0.6 per cent on Monday and Frankfurt’s DAX dropping 3 per cent. Every EM also saw a sell-off: the Nifty dropped by 1.5 per cent. But markets appear to be set to make a smart recovery on Tuesday with the DAX and Nifty recovering losses. Currency re-adjustments may have also started, with the rupee hitting new lows against the USD before it recovered on RBI intervention.
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Indian equity movements are heavily influenced by FPI attitudes. The FPIs sold roughly ₹2,2 trillion worth of Indian equities between Jan-June 2022 and they have bought around ₹54,000 crore in July-August. They started selling again on Monday, after Powell’s stance became clear. The Nifty dropped 13.8 per cent between a Jan high of 18,350 and a June low of 15183 and it has since recovered to 17,700 levels. But the bears are clearly back in business after this statement of the Fed’s future intent.
The RBI will have to respond to the Fed’s attitude as well as taking cognisance of domestic inflation. The RBI does have over $564 billion in reserves, but it has expended over $67 bn defending the rupee since the invasion of Ukraine in late February. Quite a large chunk of reserves consists of “hot money" which could be depleted quickly if the FPIs (who hold roughly $612 bn in rupee equity assets) do continue to sell in larger quantities.
India’s trade balance is in deep deficit (minus $31 bn in July) and renewed FPI selling would also mean further dollar outflows. At the same time, domestic inflation is still running high at 6.7 per cent (July). The RBI is therefore very likely to hike the repo rate again (currently at 5.4 per cent, with the 10-year Treasury at a yield of 7.2 per cent) when the MPC meets again in late September, and it may opt to go big, to match the Fed and the ECB.
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