Fed hike is good for the US markets; FII outflow from India can accelerate

The rate hike is a slight negative for markets, but not as negative if the uncertainty (trade war) had continued, says UR Bhat

On the positive side, the Federal Reserve seems to think that the US economy is headed for better times. It feels that the growth is very robust and expects unemployment to fall even further. At the same time, inflation is also on the upward trajectory. Therefore, Fed believes it is important to increase interest rates, which it has done. And, it is now talking about two more interest rate hikes, which is probably a bit more than what the market expected. 

The markets were expecting a total of three hikes in a year, but now there will be four. Even now, the market is talking of a 60 per cent chance of two more hikes. In any case, this is good as far as the state of the US economy is concerned, but it still requires some cures in terms of higher interest rates if the inflation is headed higher. 

As regards the impact on emerging markets (EMs), it is a bit negative because the US market offers better opportunities, as the growth momentum is very strong there. So, there could be some amount of outflow from the EMs. As we have seen today, most of the markets are weaker after the US Fed rate hike. The (rate hike) development can be compensated somewhat given the truce between the US and North Korea that decreases the global risk quite considerably. 

On balance, the rate hike is a slight negative for markets, but not as negative if the uncertainty (trade war) had continued. The uncertainty is less now with North Korea and the US calling truce.

Europe is likely to reverse the quantitative easing (QE). I think that would be a negative for European markets because liquidity will dry up. 

Foreign institutional investors (FIIs) have been sellers of Indian equities for several weeks now. This could continue, but there is a possibility that the selling could even accelerate. The balance of payments (BoP) situation in India is worsening with a deficit of 1.9 per cent. With crude oil prices continuing to be relatively high and exports not making much of a headway, there are problems in funds, which need to be addressed soon. Given the fact that the external account continues to be weak even though the domestic economy is in a reasonably good shape, I think the US interest rate hike can lead to accelerated outflow from India and put a brake to the bull run we have seen in equity markets. 

Domestic flows have continued to be alright. They can handle FII outflows to a limited extent, say $500 million per month. That said, domestic flows are unlikely to increase dramatically. If the FII outflow accelerates further, I don’t think domestic flows can match it. An acceleration of outflow can lead to a market correction.

On the upside, the Nifty50 can probably just about breach the historic highs, say around 11,200 levels, which is the best bet right now. The lower end of the range is 10,350. However, if this lower range (of 10,350 levels) is broken on the downside, the next support level is quite steep – at around 9,500. I think the Nifty50 should trade between 10,350 and 11,200 levels. I don’t think it will breach this range.

UR Bhat is managing director, Dalton Capital Advisors. Views expressed are his own.

As told to Puneet Wadhwa