Taper tantrums unlikely for Indian markets

Analysts now seem to be eyeing commentary on first interest rate hike from the US Fed meeting this week

With the US Federal Reserve likely to stick to the reducing the quantum of bond buying programme in its meeting this week, analysts now seem to be eyeing hints regarding the first interest rate hike from the US central bank's chair, Janet Yellen.

They, however, remain divided on the timing. While some argue might happen early than expectations given the strengthening economy, others expect the US Fed to remain in a wait–and–watch mode.

“In terms of the Fed, the market looks to be positioning itself for a hawkish shift here. The focus here is upon the possible tweaking of the FOMC’s (Federal Open Market Committee’s) statement so as to remove the current pledge that rates would remain low post the end of QE tapering for a considerable time,” points out a recent note by Rabobank International.

“Our Fed watcher, Philip Marey, expects this pledge to be removed this week but sticks to his view that a) The Fed will want to “tick all the boxes” before hiking and, b) The recovery will not proceed in as linear a fashion as the FOMC expects. As such, he continues to look for the first rate move taking place at the end of the next year (Q4) rather than in the middle as per the current consensus,” it adds.

So what does it mean for India?

Analysts believe that India will remain in a sweet spot as far as liquidity is concerned even if the US Fed winds down its QE programme. This liquidity, coupled with an overall improvement in macro conditions, has enough ammunition to take the stock markets higher.

“As the US Fed winds down its liquidity infusion program this year, the BoJ (Bank of Japan) and ECB (European Central Bank) might potentially open up their own liquidity taps—balances things out for India. The search for yield on account of further liquidity creation will be positive for capital inflows given India’s elevated interest rates,” says Prabhat Awasthi, managing director & head of equity research, Nomura Financial Advisory.

While, India’s monetary policy has tended to be largely coupled to the US Fed’s policy, their paths going forward are expected to diverge. Beginning last year, RBI under its new governor Raghuram Rajan has consistently focused on containing inflation. Rajan, who has raised interest rates thrice since he took office last September, said earlier that if he's convinced that the target of six per cent consumer inflation (CPI) by January 2016 can be achieved, the central bank would re-look at interest rates.

“The RBI doesn’t want to fight the inflation battle every two years. So the whole idea is to create an environment which is conducive for the manufacturing industry to revive by breaking the backbone of inflation. Rate reduction, in our opinion, is still far away,” said Sujoy Das, head of fixed income at Religare Invesco Mutual Fund.

In the past countries that suffered were ones that tended to have high current-account and fiscal deficits and high inflation. But under the new dispensation India has made considerable progress on these fronts. Growth although sluggish is likely to have bottomed out. Inflation is trending down and the current account deficit has narrowed. The new government in addition has reaffirmed its commitment to containing fiscal deficit.

“Market-wise, we expect falling inflationary expectations and easier liquidity to spur another round of re-rating of the market multiple in the short–to–medium term. We maintain our one-year forward Sensex target of 30,310, based on a one-year forward P/E multiple of 16.4x versus the current level of 15.6x, a three–year average of 14.2x and 5-year average of 14.9x,” Awasthi of Nomura adds.

In this backdrop, analysts expect we expect bond yields to come off by 20 – 30 basis points (bps) by November 2015. However, once the RBI starts to cut rates, they point out that the yields could rise again by 200 – 300 bps over the next two years. “Rupee is expected to hold steady if we don’t see heavy outflows and on an overall basis, we think that the RBI is doing a good job managing it,” Das of Religare adds.