For Indian markets, it’s Narendra Modi vs Janet Yellen

 

The Narendra Modi-fuelled Indian stocks rally has a new obstacle – Janet Yellen. The new US Federal Reserve chief said on Wednesday she might raise rates as early as April next year. Additionally, the US central bank trimmed its monthly bond-buying programme to $55 billion from $65 billion.

That is already having an impact as can be seen from rising US bond yields and falling Asian stocks. So far, Indian equities seem to be holding up. But the undeniable fact is that global factors, especially liquidity flowing from the US, will have an important role to play in the coming months.

A rise in US interest rates will likely see institutional investors repatriate money to their home markets. That’s what the theory says. In practice, the last two rounds of US interest rate hikes had differing impacts on emerging markets.

In 1994, the US Fed increased interest rates six times during the year from 3% to 5.5%. That not only led to a crash in emerging market stocks, but also sparked off the Mexican currency crisis.

In 2004, the US Fed hiked rates five times. But the pace was gradual; rates rose to 2.25% from 1% during that year. However, this time around emerging markets shrugged off the impact as they had started a bull run a year earlier. Economic conditions were favourable too for markets at that point of time as the world’s two largest markets by population were also its fastest growing.

Will 2014-2015 be a repeat of 2004 or 1994?

The fact that the US central bank will raise rates gradually (so as not to upset the economic recovery) is a point in favour of emerging markets. Secondly, while the direction in which rates are moving is more important, the fact that rates are near zero now will ensure that the carry trade is in favour of emerging markets. So, liquidity won’t dry up as much.

Still, unlike in 2003, there are no signs of a boom anywhere in the world. India is struggling to come off a protracted slowdown while the Chinese economy is expected to see a hard landing. Much also will depend on whether the US economic recovery is strong enough to withstand the hike in interest rate.

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