Opinion
Why US inflation seems as relevant as India’s
Summary
- Market participants are discussing US data in the same breath as India’s variables
In recent times, the Indian markets, both equities and bonds, have swayed to chatter on the formation of the next political leadership at the Centre. That apart, for quite some time, the benchmark interest rate has been having a significant impact on our markets. For central banks to take action on the interest rate, inflation is the biggest variable. Let us look at the backdrop and scenario.
A lower interest rate is a positive for the equity market. Money becomes cheaper, and as more money flows, a portion of the incremental money is invested in equity stocks. Corporations benefit as borrowing costs become cheaper, which translates to higher earnings per share.
In bonds, with lower interest rates, the price of old or existing bonds that carry a higher interest rate would move up. Globally, some central banks have embarked on a policy rate easing cycle, while most are waiting for inflation to ease to their target levels. For India—to state the obvious—the most important is the central bank’s rate decision. For the Reserve Bank of India (RBI), the important variables include inflation, gross domestic product (GDP) growth and the currency level. The market is anticipating signals from it on the timing of its policy rate easing.
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However, currently, we stand at a juncture where the variables are not exerting a strong push either way. If inflation were too high, there would be a case for a rate hike. If inflation were within the RBI’s target of 4%, there would be a strong case for a rate cut. Inflation was at 4.83% in April, much within the RBI’s tolerance level of 6%. However, it is a matter of debate whether this is low enough to warrant a rate cut. In this backdrop, global developments become all the more relevant. If central banks globally are cutting interest rates, it becomes conducive for the RBI to ease rates. If central banks stay put, it would add peer pressure on the RBI to wait for stronger domestic signals to cut rates.
Among the advanced economies, the central banks in Switzerland, Sweden and Canada have initiated a policy rate easing cycle. The big block, the euro zone, bit the bullet on 6 June; it eased its interest rates by 0.25 percentage point; the main refinancing operations rate was lowered to 4.25%. Among the emerging economies, Chile has cut its interest rate by 4 percentage points since April 2023, and Brazil by 2.75 percentage points. Peru has reduced its interest rate by 1.75 percentage points and Columbia by 1 percentage point.
In this jigsaw, the US’s action becomes important, it being the bellwether economy and market. This is in terms of taking direction when the compass does not show clear signals.
This is what we mean by saying US variables have become as relevant as India’s. When a data print is issued in India, say, Consumer Price Index (CPI) inflation being higher or lower than in the previous month, the market reads it in terms of the impact on the RBI’s interest rate decisions.
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People gauge the impact of that data on the RBI’s next rate review meeting, and how much that would move the needle. Similarly, when data prints come out in the US, say CPI inflation, non-farm payroll, job additions or GDP growth rate, people relate it in terms of the impact on the next review meeting of the US Federal Reserve.
The interest rate decision of the US Fed will influence the RBI’s rate decision. To clarify, this is not to say the Indian central bank copies or follows the decisions of the Fed. This is to say that when there is no compelling factor either way, the relevance of the move by the US becomes that much more relevant.
Apart from the next interest rate move from global central banks, there is an immediate impact on the markets. Recently in the US, yield levels on treasury securities eased on clarification that a rate hike was not on the table, as well as with inflation data coming marginally lower, the GDP growth rate being revised downward and job additions being lower than earlier.
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Yield levels on India’s government securities eased on the positive sentimental impact of easing in the US treasury yields. This being the case, market participants in India are watching for data announcements in the US along with our data, and US data is influencing our market sentiments.
The Indian market is currently expecting the US Fed to bite the bullet at its meeting on 18 September. Till then, people will watch for US data releases along with ours.
Joydeep Sen is a corporate trainer (financial markets) and an author.
