Why a spike in US inflation has spooked India's equity markets today
Friday, Jun 17, 2022
Indian equity markets were under heavy selling pressure on Friday after a sell-off on Wall Street in response to a hotter-than expected jump in US inflation that fanned expectations the US Federal Reserve will embark on a more aggressive campaign of monetary tightening and consider a single-largest rate hike in more than two decades.
What does the US inflation data suggest
US inflation rate surged to a 40-year high of 7.5 percent in January as strong consumer demand collided with pandemic-related supply disruptions. The pace of economic recovery has been much faster in the US than recovery in the supply chain, which has worsened the demand-supply mismatch and, triggered a sustained price rise.
Rate hike fear
The US Labor Department on Thursday said the consumer-price index—which measures what consumers pay for goods and services—in January reached its highest level since February 1982. And this may pressure the US Fed to consider its first half-percentage-point increase since 2000, instead of a quarter-point move.
Global markets fell
Soon after Wall Street retreated. The Dow Jones Industrial Average fell 1.47%, while the S&P 500 lost 1.81% to 4,504.06. The Nasdaq Composite dropped 2.1% to 14,185.64. It was the seventh time in 2022 that the Nasdaq lost more than 2% in a session.
Indian equities follow suit
At noon, the BSE Sensex was down nearly 900 points at 58,044.60 while NSE Nifty was down 260 points at 17,342.95. IT stocks were the biggest drag among the BSE 30-share benchmark frontline companies pack. Infosys was the biggest loser, followed by Tech Mahindra and Wipro.
"We are seeing a sharp cut in the market on the back of a sharp jump in US bond yields due to 4 decade-high inflation. However most of this fear is already factored in, therefore we have to check how the market will negotiate a high-interest environment because we have seen the scenario of rising interest rates and rising equity markets" said Santosh Meena, Head of Research, Swastika Investmart Ltd.
Why US inflation data has spooked markets
Indian markets are aligned to the US and other global markets, so if the broader global markets are falling, the same will be reflected in Indian equities too. When inflation rises, consumer spending goes down, which then affects sentiment, and this is reflected in a stock market fall.
When inflation is high, bank regulators tend to raise interest rates. Economists at Goldman Sachs now expect the US Federal Reserve to raise interest rates seven times this year to contain surging US inflation, a change from the five hikes they had seen earlier. Economists believe the Fed will move by 25 basis points at seven consecutive meetings of the Federal Open Market Committee.
"Indian investors are worried as the global inflation is high and in this globally connected environment, the world tends to follow the US markets. Global markets are under pressure after the inflation data came more than expected which has led to the speculation that the Federal Reserve may act aggressively to cool down inflation and may increase the interest rates sooner than expected. This also had a ripple impact on the 10-Year bond yield as well which led to its fresh highs. These global factors led to the impact in the domestic markets as investors are worried about the flow of money in the markets," said Likhita Chepa, Senior Research at CapitalVia Global Research.
But, why should India worry?
Foreign portfolio investors (FPIs) based in the US generally borrow in a country where the interest rates are low and invest in a country (like India) where the interest rates are high. And their profit spread depends on dollar-rupee currency fluctuations. If the US Fed increases interest rates to counter inflation-and other central banks across the world follow suit, , then the spread of US investors will fall; which means they will invest less in a country like India and this could then impact the foreign flows coming to India.
Earlier today, Federal Reserve President James Bullard said he has become "dramatically" more hawkish in light of the hottest inflation reading in nearly 40 years, and he now wants a full percentage point of interest rate hikes over the next three US central bank policy meetings. "I'd like to see 100 basis points in the bag by July 1," Bullard told Bloomberg after the US government report showed inflation rose 7.5 percent in the 12 months through January.
Point to note: There are only three Fed meetings between now and July 1, so Bullard's comments point to at least one half-percentage-point rate hike.
"The inflation data announced in the US yesterday and notice of urgent Fed meeting called for 14th Feb has increased expectations of more than anticipated rate hikes over the coming meetings. Inflation is having a high impact on household spending in the US and also impacting the popularity of Joe Biden.The impact has been visible on FPI investment flows over the last few months and the US dollar. This instability is resulting in low volatility and dollar-sensitive sectors like tech facing the fall today," said Divam Sharma, Founder at Green Portfolio, SEBI Registered Portfolio Management Service Provider.
FPI share in listed Indian stocks at a nine year low
Data from Primedatabase shows that already the share of FPIs in listed Indian stocks declined to a nine-year low of 20.74 percent as on December 31, 2021, from 21.46 per cent as on September 30, 2021. Most notably, FPIs pulled out Rs 44,820 crore from Financial Services and Software sector during the quarter. Holding of FPIs (in Rs value terms) in companies listed on NSE stood at Rs 53.78 lakh crore as on December 31, 2021, a decrease of 1.67 per cent from Rs 54.69 lakh crore as on September 30, 2021.
US accounts for over 30% of FPI inflows into India
Now, in terms of geographical spread, data shows that in terms of value, at least 30.32 percent of FPIs that invested in India in the December quarter were from the US, and this is the highest share compared to all other countries.
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