Fed Hike Positive for Bonds and Rupee: Ind-Ra

Mumbai: The US Federal Reserve’s decision to formally mark the end of its Unconventional Monetary Policy is a welcome sign of normalization, which will augur well for domestic financial markets, India Ratings and Research believes. Specifically, the rates and currency market will stand to gain in the near term; the 10Y benchmark G-sec yield likely to soften around the 7.70% mark with bias towards further softening and the Indian rupee will stabilize between 66.3-66.6/USD during the week. With Fed’s policy normalization underway, the Reserve Bank of India’s (RBI) focus during the upcoming monetary policy reviews will increasingly shift to domestic parameters- critical being the growth-inflation rhetoric.

For financial markets, with looming uncertainty over the Fed policy path behind, the driver for markets hereon will be more inward focused than external developments’ reliant.

Specifically, the rates market in the near term is likely to stabilize hereon on the back of (1) no supply pressure of G-sec in this fortnight (2) the next tranche of debt limit hike for portfolio investors for both central and state government bonds opening on 1 January 2016 (3) gradual and non-disruptive rate hikes by Fed in 2016 keeping the door open for RBI to ease rates, basis assessment of evolving macro parameters.

The elimination of uncertainty post the Fed event emerges as a major positive for domestic bond market, which has been witnessing foreign outflow. Over November 2015-first week of December 2015, equity outflow stood at around USD1.7bn, while debt outflow totaled USD580m. Incrementally, outflow from India is likely to moderate. Ind-Ra believes future inflow is likely to be more long-term flow than ‘hot’ money.

In the currency space, we have been highlighting that the rupee is likely to correct from the recent lows of 67/USD to around 66.3-66.6/USD mark (Insert DebtFX link). A dovish rate hike by Fed is likely to be positive for the EMFX space as questions persist not only over the timing of further rate hikes but also on the extent. The first rate hike comes against the backdrop of low inflation (in part, explained by ‘transitory’ pressure of energy prices). The US dollar weakness, consequently, may be an interim phenomenon with subsequent rate hikes likely to shift the orbit of dollar strength outward.

The rupee is likely to emerge as a gainer in near term. Ind-Ra believes the rupee is likely to gain in today’s trading session and consolidate in the 66.3-66.6/USD range. Its better placed macro fundamentals indicate that the rupee could continue outperforming both in absolute and relative terms.

On the ground level, the impact of policy normalization by Fed is unlikely to have any fundamental shifts in the outlook for the Indian economy. Indian corporate sectors continue to face pressure of excess leverage at a time when growth recovery is protracted, leaving a debt overhang. An appreciation in currency, accompanied by low energy prices, will have a salutary impact on corporate balance sheets. Any meaningful turnaround, however, is likely to be only slow and gradual.

The Fed rate hike needs to be assessed as reasonable confidence US policymakers have on the revival of their domestic growth conditions. While other major economies continue to battle recessionary trends, the US economy’s strength may have positive spillovers for its trading partners.

The stabilization of external market conditions indeed provide opportune time for domestic policymakers to revive the issues plaguing the corporate sector. They can focus on resolving the problem of stressed assets, creating demand and augmenting the capital expenditure plans.