Despite US Fed's aggressive stance, FPI flows, inflation trend hint to peak QT cycle in CY23, says ICICI Securities

US and Indian bond rates have held steady at about 3.7% and 7.3%, respectively, despite continuous quantitative tightening (QT) and hawkish remarks from the US Federal Reserve during its most recent Federal Open Market Committee (FOMC) meeting, according to brokerage ICICI Securities.

Also, despite the hawkish approach that suggests market expectations of an interest rate peak in CY23, foreign portfolio investment (FPI) flows to India and other emerging economies have remained comparatively constant.

According to a media report, foreign investors have continued the positive momentum after investing over 36,200 crore rupees in Indian equities last month, and added a net total of 10,555 crore rupees to the market so far in December.

Between September 2020 and December 2020, FPI holdings reached their high. June of this year saw the lowest FPI flows, but the trend is now reversing.

"Reversal of FPI outflows in H2CY22 has resulted in FPI holding of Indian stocks forming a bottom at 17% and now climbing up to 17.3% in November," said the brokerage.

Concerns about financing the current account deficit (CAD) reduce as FDI inflows stay strong and FPI selling turns around. Forex reserves have been increasing and reached US$564 billion in December.

According to the brokerage, domestic economy sectors like financials, consumer discretionary, industrials, FMCG, healthcare, and telecom have been the main drivers of FPI buying in H2CY22 (until 30th Nov'22). FPIs, however, supplied products in industries like energy and IT that were influenced by global issues.

As a result, as of November 30, 2022, total FPI equity investments were worth 49.9 trillion rupees, or 17.3% of all listed Indian equities (288.5 trillion rupees).

"The monthly systematic investment plan (SIP) flows into mutual fund schemes have touched all time high of 13,300 crore rupees," added the brokerage.

Auto, consumer discretionary, healthcare, and financials sectors saw the biggest mutual fund purchases in H2CY22 (till November 30), while metals, telecom, and IT sectors experienced outflows.

Moreover, domestic flows also continue to trend positively, and according to the brokerage, they have passed the litmus test of extreme events like the omicron wave, unprecedented QT cycle in terms of jumbo rate hikes, the conflict in Russia and Ukraine that caused a risk-off environment, and the subsequent spike in commodity prices over the past year.

Risk - Going head

According to ICICI Securities, the concern moving forward is that there might be gradual, sudden outflows from emerging economies like India if the present forecast of a terminal interest rate of about 5% for the US is breached on the upside.

"Upside revision to the US Fed’s dot plot seen post the December 22 FOMC meet highlights the above risk. However, going by the current inflation trajectory which undershot expectations, the likelihood of terminal rate rising further remains low in our view," added the brokerage in its report.