Will surprise Fed rate cut mean more FPI flows to India? Here’s why it won’t

Le Fonti International – March 6, 2020
March 6, 2020
The Fed surprises with a rate cut – high volatility on Wall Street
March 9, 2020

Will surprise Fed rate cut mean more FPI flows to India? Here’s why it won’t

NEW DELHI: Stock markets’ reaction globally to the emergency 50 basis points rate cut by the US Fed has been tepid.

Instead of welcoming the rate easing, investors turned more cautious, unsure as to what made the US central bank not wait for the March 17-18 policy review and go for the first unscheduled rate cut since the global financial crisis of 2008. Some analysts said the Fed action actually fueled fears of recession in the US economy.

Supply disruptions from China, the world’s manufacturing factory, and its impact on US companies must surely have been on the Fed’s mind. But analysts said the world needs more of fiscal than monetary measures to come out of this distress.

The overnight development raised two questions for investors on Dalal Street: whether India could see a rise in foreign inflows given the liquidity easing globally, and secondly, whether RBI will follow suit and cut policy rates further.

Analysts had no clear answers.

Fed rate cut & FPI flows
Historically, any easing by the US central bank has brought money into emerging markets, including India. As emerging markets led by China have been facing virus scare and economic slowdown, analysts have mixed outlook for these markets.

Peter Cardillo of Spartan Capital Securities said interest rates coming down in the US might mean some money flow into emerging markets, which are offering higher rates of return, but there are risks globally and investors will largely be looking at typical hedges.

“The best hedge today is gold. We saw that on Tuesday when the yellow metal jumped over 3 per cent. In overnight trades, it looked as though it was set to move even higher,” Cardillo said.

Seth R Freeman of GlassRatner Advisory said the recent developments would be negative for emerging markets because of ‘stereotypical’ uncertainty. He felt investors globally would not be going to emerging markets under the prevailing conditions.“With regard to Asian equities, index funds can cause a lot of damage. If investors of an index fund are bailing out because of a specific-country exposure like China, other Asian countries in that fund would also take a hit. It is going to push down markets of other countries in the same way. That is one of the risks in those markets,” Freeman said.

Data showed FPIs pulled out Rs 13,400 crore from domestic equities in last six sessions.

“On the positive side, yields in the US are dropping and professional investors may see an opportunity to get higher yields in emerging markets in such a low-yield environment,” he said.

Raamdeo Agrawal, Chairman, Motilal Oswal Financial Services, and a seasoned Dalal Street investor, says ETF flows have been dictating market direction.

“Out of, say, $4 trillion of ETF money, even if 5% wants to encash, you are talking about at least $200 billion of redemption, and that too overnight, in a jiffy. ETF redemptions are there and those redemptions are being encashed here. That can cause vertical decline, which has happened, and they can also cause vertical upward shift because having taken $200 billion out if they want to again get in $200 billion in very quickly, then obviously recovery will be very fast,” Agrawal said.

Fed rate cut & RBI review
Past episodes of crisis-related easing cycles by the US Fed and concurrent RBI actions suggest while the rate cycles are directionally synchronised, they do not move perfectly in tandem, said Nirmal Bang Institutional Equities.

“RBI has been pre-emptive in cutting rates, with cumulative rate cuts amounting to 135 bps so far, which was marginally higher than the Fed’s cumulative rate cuts of 125 bps in this cycle. While additional long-term repo operations and possibly more ‘twist operations’ are likely, we do not expect RBI to cut rates immediately until inflation cools down,” the brokerage said.

The dovish Fed stance and an accommodative RBI will likely support a mild rally in bond yields, but this may be offset by continued FPI selling pressure, the brokerage said.
What’s ahead of domestic stocks?
Volatility as suggested by India VIX has spiked to 25 level from 10 level. ICICI Securities said Nifty had in last 10 years bottomed out within 1-2 months in six of nine instances of posting a 11-13 per cent slide.

The index has already fallen 10 per cent. “Nifty has an important support at 10,800 and its worst case scenario seems to be close to 10,400,” the brokerage said.