how fund rate of fed affect indian markets
The recent decision on 13th December by the Federal Reserve to maintain its key interest rate at 5.25%-5.50% has set off a chain reaction with serious implications globally (including India). So, in this blog we will delve into the intricacies of the Fed's pause and forthcoming rate cuts in 2024, exploring its effects on the US 10-year Treasury yield, and the consequential impact on Indian equity markets.
The Federal Reserve's decision to keep its key interest rate unchanged for the third consecutive time sends an important message. While focusing on curbing inflation, the Fed does not want to negatively impact the economy. The Fed also anticipates three quarter-point cuts to its benchmark interest rate in the latter half of 2024, signaling a commitment to managing economic growth cautiously.
One of the notable consequences of the Fed's pause is the substantial decline in the US 10-year Treasury yield. Now you may wonder how this happens. Well, the moment the Fed signals that rate cuts are on the cards, investors flok to buy risk-free US 10Y Government bonds available at a higher yield (of more than 4 to 4.5%). So due to the high demand, the price of bonds goes up and this results in a decline in the yield!
Source: CNBC
In the last week (9/12/23 to 16/12/23) the US 10Y Treasury yield has decreased by 30 BPS from 4.23% to 3.93%. This shift in the bond market reflects changing expectations regarding future interest rates and inflation. Understanding this dynamic is crucial for assessing the broader implications on global financial markets.
Let’s analyze how lower bond yields impact fund flows around the world. In the world of investing, investors chase only one thing. Returns! Now, if they can get more than 4.5% risk-free returns by investing in US treasury bonds, they keep on mounting money. But once the risk-free rate becomes less attractive, they have to divert their money into more risky markets. That is why equity markets around the world see higher liquidity when bond yield goes down.
This outflow of money from safer markets to riskier markets in the pursuit of high returns is bound to come into the emerging markets. Many developed countries are going through a recession. Many others are in line to join the party in 2024. So emerging nations become an attractive avenue of investment. Which country is the best placed among emerging markets? INDIA! We are growing at the fastest pace among large economies. There are no major economic concerns at the moment. It is like an elephant has started to dance. And when that happens, everyone wants to be a part of it.
That is why FIIs have started to pour in money in Indian equity markets. In the last week (11/12/23 to 15/12/23) FIIs have bought more than Rs. 18000 Cr. worth of equities in the cash market.
Fundamentals of the Indian economy are strong; inflation is not out of control; the economy is growing at a record pace; tax inflows are robust; and SIP inflows are at a record high! And along with strong SIP inflows, these FII inflows will take Indian markets to new highs!
Foreign institutional investors (FIIs) have already initiated substantial flows into India, and the trend is poised to intensify. The prospect of higher returns amidst global rate adjustments positions India as an attractive destination for investment.
Reading all this positive information you may wonder “Is this the right time to invest?” The answer is yes and no! Yes, these next five to ten years can be the biggest wealth creators for Indian Equity investors so you should definitely invest in the Indian markets. But at the moment, pockets of undervaluations are rare in the market. There is a lot of froth in the small and midcap space.
So, we feel that you should continue with your SIPs. But while deploying fresh lumpsum capital, you should not compromise the quality of business and pay for unjustified valuation. We feel that at this moment, large caps are better placed as an investment avenue in the Indian stock market.
The Fed's pause and potential rate cuts in 2024 will have a massive impact on the fund flows in emerging markets. India being the brightest spot in emerging markets will see high inflows. But that being said, valuation is not very favourable in the small and midcap space. So, investors should deploy fresh capital with some caution. We believe that the strong economic growth of the country along with robust fund flow will be beneficial for the market. And the next few years can be the best time period for the Indian financial markets.
