Rupee trades higher as Fed signals slower rate hikes

The domestic currency strengthened on Thursday morning trade against the US Dollar post US Fed Reserve Chair Jerome Powell’s comments hinting a slower pace of rate hikes than previously expected. 

The Indian Currency opened at 75.63 per US Dollar and was the last trading at 75.68 per dollar against its previous closing of 75.70/$. 

On Wednesday, Rupee closed at the lowest levels since December 2020. So far in the day, the local currency swirled between 75.6470-75.6800 against the greenback.

In a recent update, Powell hinted at a 25-bps hike in March against the expectations of a 50-bps hike, considering that the world’s largest economy’s inflation is at 40-year highs.

While Powell’s statement lent some comfort to currency traders, soaring oil prices kept the investors’ sentiment low.

Domestically, Indian benchmark indices were trading higher after falling drastically earlier this week. BSE Sensex was at 55,624.17 points against its previous closing of 55,468.90 points, up by 155.27 points. NSE Nifty was at 16,641.40 points, up by 35.45 points against the previous closing of 16,605.95 points.

On the international front, Brent Crude Oil futures crossed the $110 mark on Wednesday and was currently trading at $116.76 per barrel, up by 3.39% against its previous closing. 

Oil prices are marching upwards ever since the Russia-Ukraine conflict fired up, and continues to move in a higher band.

Explained: How US Fed rate hikes could impact Indian markets

For this, we first need to understand why foreign investors invest in India? Why don’t they invest in the US?

In contrast to the USA, an already developed nation with limited growth possibilities, India is still a developing economy with massive growth opportunities.

Moreover, Interest rates in the USA are much more relaxed than in India. So what foreign investors will do is, they will borrow heavily in the USA markets and infuse that capital in the Indian markets, where interest rates are high. 

This significantly reduces their borrowing cost, which could have been higher if they restore to borrowing the same capital in the Indian financial markets.

Let’s take an example, suppose Jhon, a foreign investor borrows 1 lakh US dollars by incurring a borrowing cost of 3%. Then, he invests the amount in the Indian stock market and earns 12% annual returns.

After a year if he takes his capital out from Indian markets. His net interest profit will be around 9% out of 12% (3%, which he need to pay interest towards a loan in the USA. 

Note: Profit may fluctuate with currency fluctuations.

Imagine If he borrowed this capital from Indian banks, he would have ended up paying 7-8%(even in the case of Private Lenders) Borrowing cost.

Not just India, markets globally are affected when interest rates are hiked in the USA. Firstly, rate hikes result in foreign investors cashing out from the Indian stock markets, as Indian markets would be far less attractive to them.

The rate hike motivative foreign investors to pull their money out of the Indian markets and invest in their own country.

Finally, the changes in the USA fed rates don’t take place overnight. So, the news regarding any significant step to be taken by the Federal Reserve starts roaming around the markets months before the news gets a nod from the Federal Reserve. This serves the equity markets with ample warning and time to prepare, eliminating any wild moves.