Skyrocketing inflation, interest rate hikes by central banks globally and new lifetime lows made by the rupee have been causing all the ruckus for some time now. 

With the pound, yen, and euro on a slippery slope, the dollar index, which tracks the performance of the greenback against other major currencies, has managed to rise to its two-decade high of 105.56.

With the expectation of stagflation/recession and slowing global growth, investors are seen flocking to safe-haven instruments. Britain has downwardly revised its growth projections on account of rising inflation backed by the ongoing war in Ukraine and an impending trade war. Even the European central bank has announced a rate hike in their July meeting, their first in 11 years. The currency markets are witnessing the biggest monetary policy tightening ever, which is further accentuated by a global withdrawal of liquidity. 

The US Federal Reserve conducted its biggest rate hike in 28 years, raising its interest rates by 75 basis points (bps), in a bid to counter an 8.6% rise in inflation, the largest year-on-year increase in 40 years. This was followed by a huge sell-off in the equity markets with Dow jones now having fallen 20% from its peak. The treasury yield curve, which plots the return on Treasury securities, was inverted (albeit temporarily) with the yield on 2-year treasury yields being more than 10-year Treasury yields, an alarming signal because it is considered a leading indicator of recession.

The US 10-year treasury yield touched a high of 3.5%, the highest since 2011 to later fall with rising bond prices as more investors looked toward US bonds as a safe bet. The US 30-year mortgage saw its biggest one-week jump in 35 years going to 5.78%, the highest since November 2008. Mortgage demand is falling with rate hikes, causing a sharp turnaround in the market. 

The Fed, in their recent meeting, stated that they are strongly committed to returning inflation to 2%, although with the current fundamentals it looks like a pipe dream. Investors are now preparing for the possibility of a dented future growth and that the promised soft landing by the Fed will not be delivered. The dollar is, however, still increasing, despite these bleak data points. This is because of the dollar smile theory, wherein the dollar strengthens in recession (because of the safe-haven throne it occupies) as well as during growth. Because of this dollar is expected to remain elevated even with weak macroeconomic data. 

Oil fell by 9% last week because of the looming uncertainty over the global growth outlook and the expected reduction in demand for fuel. The US department of energy announced a sale of 45 million barrels of oil from the Strategic Petroleum Reserve (SPR) as part of the Biden administration. This is the largest ever dig in the stockpile with the intention to control the recent oil price spikes.

With RBI’s focus on withdrawing their accommodative stance, repo rates were increased by 50 bps to 4.9%, now up 90 bps in five weeks. The decision was taken to curb the rising inflation pressure, which was 7.04% in May, lower than 7.79% in April. 

The rupee may take a breather with a correction in oil and bond prices. The Nifty 50 Index is now at its 52-week low, giving 0% returns over the year, a sure hole in several investors’ pockets. FIIs have now withdrawn $25 billion from Indian equities year to date. The Indian rupee was expected to feel the heat with a blood bath in global equities but the damage was fairly controlled with RBI using forex reserves to contain volatility.

The forex reserves now stand at $596.45 billion, acting as a cushion in these times of high volatility across all asset classes. India may see a twin deficit issue in the economy with rising commodity prices and a higher subsidy burden. Government revenue has reduced due to cuts in excise duties on diesel and petrol. There exists an upside risk for both fiscal and current account deficits.

China is once again caught in a Covid case rise and the possibility of a lockdown driving down demand. These factors have eased the Brent from its recent high of $140 per barrel. The prices will, however, continue to be on the higher side, with a fall in production due to unrest in Libya and the Russia-Ukraine war causing supply-side issues.

The graph depicts an inverse correlation between Nifty50 and USDINR over the last six years along with the FII net inflow or outflow figures (INR crores). In these times of global pessimism, along with the rupee’s depreciation (USDINR going up), the Nifty is also falling. Interestingly, the Indian equity market has not witnessed two consecutive years of net FII outflow in two decades. If history is any guide, we should ideally see FII inflows in the second half of the financial year to compensate for the three months of outflows seen to date. Whether we will see a new record in terms of two back-to-back years of outflows or not, only time will tell.

The market participants have discounted most of the negative news and we can hope for a pullback or a dead cat bounce. With the tug of war between supply concerns and an uncertain global growth outlook, India is expected to have a slower growth, although still higher than other emerging economies. 

The rupee has been able to hold its ground against the dollar if we compare it with Asian peers, the Korean won, Japanese yen, Thai baht, and Malaysian ringgit. Despite the numbers acting to the rupee’s disadvantage, it has managed to avoid a steep fall, much to everyone’s surprise. The rupee may first test 77.50 levels but has a rough journey ahead, hitting the roof at 80 by the end of this year.

(Ritesh Bhansali is Vice President at Mecklai Financial)