Rising US interest rates; shaky Indian Non-Banking Financial Companies (NBFCs)
How are the Indian and global economic environments affecting the financial markets?
This week has been a double whammy for the Indian financial markets. First, amid the rising global oil prices, a hawkish US Fed has triggered fears in the financial markets that US interest rates could possibly rise more aggressively than expected, leading to outflow of dollars from emerging markets such as China and India prompting warnings from the International Monetary Fund (IMF) about risks to global financial stability and growth. Fed fears have raised global bond yields and prompted a steep sell off in the equity and foreign exchange markets in emerging economies, especially in India where, together with the fall in equity markets, the rupee has fallen about 14% relative to the US dollar this year. Besides the rising US dollar which has softened a bit after rate fears, currency markets are preferring currencies such as the euro and yen because of trade surpluses in Germany and Japan. Fed fears becoming a reality will depend on the core personal consumption expenditures rate of inflation (PCE without the volatile food and fuel components) – the Fed’s preferred inflation measure – and its outlook. It is more than likely that, economic conditions remaining as expected, the Fed, notwithstanding US president Trump’s expression of displeasure with Fed policy, will stick to its published gradual interest rate increase path through 2020 because the current stance of the Fed on interest rates is that the Federal Funds Rate (FFR) is neither accommodative nor neutral. The gradual rate of increase in interest rates, keeping in mind both growth and inflation, will ensure that the Fed will not overshoot the neutral rate, inadvertently slowing down the US economy or causing a recession. The Fed may have to reassure the markets that it continues to remain on the gradual interest rate increase path. Second, the domestic NBFC situation and pressure on the Indian banking sector which the regulators are working on is pushing the markets down. The Reserve Bank of India (RBI) should continue to act based on CPI inflation vis-a-vis its inflation target of 4% in the medium-term even if it means slowing the Indian economy a bit to contain inflation.
What to expect from the markets next week?
The markets will continue to react to the oil price, rupee, global cues on interest rates, and stabilization of the NBFCs. This year, thus far, as we have predicted, given the domestic macro and sectoral situation and external environment, the Indian markets have sharply corrected down. We expect this downward pressure to remain especially given the outlook on energy prices and inflation. To watch are the corporate earnings for the July-September quarter and their affect on the markets.
Hedgeloop Performance Summary for a Sample Client Portfolio from 01/01/2018 to 10/10/2018
As can be seen from the above table, we mostly advised SELL since the beginning of the year and the market moved down steeply, correcting twice by falling about 10% from the 52-week high – once early in the year and now. Given the data, we never expected a secular bull market trend. The markets were looking for triggers to correct down because they were expensive based on fundamentals and technicals and given the negative macro and external pressures. Fears of inflation, interest rate rises, oil price rise, rupee depreciation, US-China trade war, US-Iran geopolitical isssues and their implication for the oil price, and possibility of contagion due to the NBFC crisis in India have provided those triggers. Our predominantly SELL advice from our artificial intelligence models, based entirely on the mathematical models of the data, has been consistent with fundamentals, technical, sentiment, domestic Indian regulatory and macro, and external factors driving the market, generating a cumulative P&L for the portfolio of 118%.