On Wednesday this week, the federal reserve announced that it is keeping the interest rates near zero as a measure to provide another round of respite to the debt and equity markets in the United States and across the globe. Although it did not support any interest rate hike through 2023, the Federal reserve maintained that it will not stop the monetary flow of credit to business and households to give the economy the much-needed space to flourish rightly after the coronavirus pandemic struck the entire system hard.
Everybody is aware of the fact that the United States enjoys a substantial amount of potency when it comes to global politics and the world economy. This also means that any step or any decision affecting the US economy shall have an effect on the rest of the world as well. Well, this decision by the Fed had it too. The investor sentiments across the globe were boosted, leading and encouraging a jump in major indices of the globe. However, the same wasn’t very welcoming for the Indian market- despite opening on a strong note, the Indian indices fell by over 1% the day after the announcement (Thursday). The Sensex dropped by 1.2% (585 points) to settle at 49,216 points on Thursday. It has witnessed an unhappy session over the last five trading sessions recording drops of 2,063 points or 4%. Therefore, the weakness of the Indian investment sentiment continued even after the investment-friendly announcement by the Federal Reserve. Despite the equity and debt markets rising all over the world, the Indian market participants believe that the market might witness some correction soon. These corrections might be on account of concerns over rising in bond yields as well as another spike of worry over the rise in the number of coronavirus cases being reported in the country.
What is the announcement made by the Fed?
Maintaining that the economic recovery path will be significantly dependent on the course of the coronavirus pandemic and its inoculation process, the Federal Open Market Committee (FOMC) looks forward to standing by an accommodative stance in its monetary policy. The same is expected to stay until the country achieves maximum employment and an inflation target of 2% over the longer run.
The Federal Open Market Committee is expected to keep the target range for the federal funds rate at 0 to 0.25% until the labour market conditions have reached the desired levels. It believes that maintaining this target range shall be appropriate until inflation in the country has risen to the targeted 2 per cent and is further on its trajectory exceed the 2 percent mark.
The Fed shall also persistently increase its holdings of Treasury securities. It has set a target of at least $80 billion per month for the same. Along with the Treasury securities, it shall also increase the holdings of agency mortgage-backed securities by at least $40 billion per month. This is expected to go on until substantial further progress is made to achieve the maximum employment and inflation goals set by the committee. These purchases of these financial assets will help foster the credit flow in the economy while ensuring the smooth functioning of the market.
Experts believe that the rise in bond yields have much larger impacts on the debt and equity market in comparison to the near-zero interest rate, perhaps being one of the major reasons for a disconnect between the market and central banks. Although central banks have control over the policy rates and can decide to keep them low, the long-term bond yields are highly affected by externalities such as expectations of higher growth and inflation. Pankaj Pandey, head of research at ICICIdirect.com, is of the view that when the yields start rising, they start competing with equities, ultimately impacting the entire equity market movement.
How will this affect the Indian markets?
Many experts believe that with the announcement by the Fed that there may not be a rise in interest rates through 2023 the markets would witness a calming effect. The markets have been showing worrying emotions with expectations of a rate hike earlier than expected. On the same lines, C J George, MD, Geojit Financial Services, says “If we go by that, it will have a soothing effect on both the debt and equity markets. It gives nearly two years’ time and that will provide stability to the markets.”
There are people with views that if a sudden rise in bond yields invited concerns on FPI fund flow continuation, the Fed’s latest announcement shall ensure the strength and upwards trajectory in the equity markets. Others, however, believe that with the incessant rise in the US bond yields, emerging equity markets shall have a major impact on the fund flow.
In line with a surge in US bond yields and the bond yields in other developed markets, the G-Sec bond yields rose by 0.2 per cent to 6.2 per cent on February 22 from around 6% on February 15. They have stayed around the same levels till today.
Furthermore, one should also take into consideration that the Foreign Portfolio Investors (FPIs) have sustained their net investments of Rs 38,764 crore in the Indian equity markets in comparison to a pull out of Rs 15,700 crore from the Indian debt market by the same group of investors between February and March 2021.
The Sensex has witnessed a fall of over 4 per cent over the last five trading sessions. During this time, the FPIs have made net investments of Rs 15,700 crore. This came when the domestic institutional investors (DIIs) sold Rs 3,750 crore worth of equity holdings.
Are the markets expected to rise now? What will be the new investor sentiment?
The investor sentiments have been dampened by a multitude of external factors affecting the markets such as:
- Rising bond yields,
- Surging Covid numbers in many parts of the country, and
- Announcement of lockdowns by various state governments.
All this volatility has given people some profit booking chances on highs. The general perceptions about this announcement are that with central banks doing their best to support their respective economies by providing the much-needed liquidity and credit flow (by keeping the interest rates low), the equity markets will further witness an upward ambit.
However, despite this belief, investors are likely to keep a close eye on the rising bond yields with expectations that when the US bond yields inch closer to a 3 per cent interest rate, the equity markets in both developed and emerging countries will start to feel the downslide. Not much impact is expected till the time the market bond yields in the US loiters around the levels of 2-2.25%.
The equity markets will be impacted by not only the concerns around bond yield and surging positive Covid cases but also by profit booking sentiments among investors.
The economy shall further stabilize with the proceeds of the ongoing vaccination process as more and more people receive their jabs over the next three to six months. The stabilization of employment, growth and global liquidity flow is likely to further push the markets.