Will They, Won’t They?

interest blogOne of the biggest threats that the equity and bond markets in India face this year is the impending interest rate hike by the Fed. Interest rates in the US have been zero since 2008 and since the US economy is on the path to recovery a hike in the interest rates is quite likely in the near future.

                How does this affect us in India? Broadly, this signifies the end of easy money for institutions to invest in emerging markets.  This implies that the risk adjusted returns from equity markets that they were getting by borrowing in the US and investing in India will reduce and Indian equities will look less attractive. This could mean a sell off from Indian markets and money returning to the US. This could also weaken the Rupee.

Historically, in the months leading up to an interest rate hike the stock markets have underperformed and 13 of the 16 times the rates rose since 1945, the S&P 500 has seen a pullback or correction 6 months prior to the hike.

                In the debt market the situation is similar. A rising interest rate scenario in the US and a falling interest rate scenario in India, diminish the arbitrage opportunity. Safer US treasury bonds look more attractive than the lower rated Indian government securities, this could again push FII Investments out of the Indian bond market, leading to a temporary fall in prices and a rise in yields and further hurt the Rupee. Having said that, the absolute arbitrage still remains significant and will continue to attract long term investors.

                Of course, the hike has been looming over us for a while now and the Fed has been tight lipped about their schedule. They will only act when the recovery seems more stable and certain. This has kept analysts guessing whether they will or they wont for at least a year now.

                So what should we do when they eventually do hike the rates? Rather than panic and exit the market, this should be viewed as an opportunity to accumulate more equity, especially as an interest rate hike suggests that the US economy is well on its way to recovery which is generally good for the world.

AUTHOR: Varun Shinde , Senior Advisor LIN logo 

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