Fed Rate Hike No More a Worry?

Fri, 16 Dec Pre-Open

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Finally, on Wednesday the US Federal Reserve raised its target federal funds rate by 0.25% to between 0.50% and 0.75%.

The Indian stock markets reacted to the news quite nonchalantly. The BSE-Sensex closed lower yesterday by 84 points (down 0.3%).

In our view, the 0.25% rate hike was widely expected by market participants. So, the move didn't come as a surprise.

That said, 2016 hasn't been a favourable year for the Indian capital markets in terms of foreign investments. In fact, it's set to be the worst in the last eight years.

Surprised?

Let us explain. The Indian capital markets include both equity and debt market. While there have been net FII inflows in the Indian equity markets in 2016, the debt market in India has witnessed significant outflows. As per an article in Business Standard:

• The net outflow by FPIs in the debt market is already more than USD 6.2 billion (nearly Rs 43,000 crore) this year with a few days of trading left, which far exceeds the net inflow of less than Rs 30,000 crore (USD 4.3 billion) into the equity market.

It must be recalled that the global financial crisis of 2008 had resulted in a massive outflow of over Rs 412 billion by foreign portfolio investors.

Many investors don't pay much attention to the debt market (or bond market). But it's a big mistake.

Here's our global expert Kim Iskyan from Truewealth Publishing, Singapore:

• In case you didn't know, world's largest securities market is the bond market - not the stock market. About US$700 billion worth of bonds trade every day - compared to the US$200 billion worth of stocks that trade per day. But, as we've explained before, bonds aren't the life of the financial world's party, so they often get overlooked.

One of the key factors that has been a major trigger for the outflow of foreign investments from the Indian capital markets (the other major trigger has been the demonetisation drive) is rising yields in the global bond markets. Bond yields have been firming up in recent times in anticipation of the Fed rate hike. The latest Fed rate hike validates the trend.

But there seems to be more. The Fed's outlook is now for three more 0.25% hikes in the coming year. And then another three increases in both 2018 and 2019. This would mean nine rates hikes over the next three years before the rate levels off at a long run 'normal' of 3%.

We doubt the strength and durability of the US economic recovery since we believe it has been driven mainly by massive doses of money printing and artificial suppression of interest rates.

Hence, we also doubt the Fed's capability to further raise interest rates.

Either way, there is going to be trouble. A quick succession of rate hikes will create a massive storm in the global financial markets. No rate hikes will lay the ground for much bigger financial storms later.

Be prepared to witness heighted volatility and uncertainty in the global financial markets in the coming months. And do not take the nonchalant reaction of Indian stock markets to the Fed rate hike as a sign of confidence and optimism. It's not over yet.

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