Financials in focus ahead of FOMC meet

The US central bank has been considering a hike in the US Fed Funds rate for a while

Every meeting of the US' Federal Open Markets Committee (FOMC) is guaranteed to set off some turbulence. This one will likely be no exception. This week will see every major financial market taking cues from Wall Street. Once the FOMC meets, rumours start flying about likely Fed action. This results in anxiety and translates into market volatility.  

The Fed has been considering a hike in the US Fed Funds rate for a while. The US economy has seen a recovery, with several years of steady job creation and reasonable GDP projections. However, consumer sentiment is weak; inflation is nowhere near the ‘magic number’ of two per cent; and the global economy is looking increasingly weak. So, a case can be made either way, for a hike or not. Consensus expectations going into the week suggested that about 30 per cent of market participants expect a hike. So, there could be a bearish session or two.  If there is a hike, this will be followed by some more bearishness.  If there is no hike, there will be some kind of relief rally across every big market.

Given the time differentials, Indian markets line up one day behind the US in terms of dates. Given the Ganesh Chaturthi holiday, volatility in India will be even more because trading will be compressed into fewer sessions. Therefore, Friday could be a big session in India, one way or another.  

The trader would be concerned with the short-term consequences of Fed action. If there is a hike, there would be a sell-off in the US bonds markets and also in US equities. If that possibility has already been partially discounted due to the 30 per cent consensus expectation, the potential impact may be less. However, bond yields would rise in the US markets to some extent even if people are braced for a hike.  That should mean global fund flows into the US treasury market. In turn, that should mean dollar hardening against most other currencies and probably, a correction in emerging market assets.

The Reserve Bank of India (RBI) meets on September 29, and its policy decision will certainly take the Fed action, whatever it is, into account. India's Index of Industrial Production has registered stronger than expected. But, the inflation data are indicating a sharper drop in prices than expected.  

That could influence RBI into a rate cut. So, the hope of rate cuts will be built into Indian equity prices, especially into share prices in the financial sector until September 29. My guess is, if the Fed does not hike, RBI will in all probability, announce a cut on September 29, or perhaps even earlier. But if the Fed does hike, RBI mightdecide to hold the repurchase rate at the current level for a while, in order to let currency rates stabilise before taking any action. Either way, there will be a strong focus on the financial sector over the remaining part of the September settlement (ending Sep 24) and heading into the October settlement. The Bank Nifty in particular will be a favourite instrument for traders, who will also be looking at highly liquid NBFCs like LIC Housing, HDFC, IDFC, etc. Other rate sensitive sectors will also see action.

A cut in the rupee repurchase rate looks almost guaranteed now, given latest inflation numbers. But RBI can tinker with the timing. The cut (or cuts) could come anytime between now, and January 2016. Dr Rajan seems to have a fondness for surprising markets with out-of-turn cuts ( the last two cuts were both unexpected). He might choose to delay, depending on the Fed action.

The author is a technical and equity analyst