The three important factors, which would affect all asset classes in the short term, are the behavior of oil prices, the behavior of Omicron and the behavior of inflation, thus affecting the interest rate scenario in the 3 to 4 months ahead.
In 2021, oil prices rose nearly 55% after falling into negative territory in 2020. Rising oil prices will keep inflation higher, keeping most central banks in a hawkish mood.
In fact, gas prices, higher carbon prices and OPEC guaranteeing that the increase in production is not large will guarantee that oil prices will remain higher for a longer period of time.
We spoke to Anil Kumar Bhansali, Head of Treasury, Finrex Treasury Advisors, about the impact of oil, Omicron and inflation on interest rates in 2022:
Oil:
Oil is India’s main import and every $10 increase in oil prices increases our CAD (current account deficit) by $14 billion and widens the CAD/GDP ratio by 0.5%.
Until December 2021, our exports had grown to $300 billion and are expected to surpass $400 billion by March 2022. However, part of the increase in exports is also due to rising inflation and rising freight prices.
Our imports have increased dramatically, bringing the current account to a negative balance in September and another negative balance is expected in December and March.
The monthly trade deficit for the past 4 months has reached $22 billion. In the coming months, most analysts expect oil prices to rise above $100 a barrel as demand outstrips supply. This would surely put pressure on our current account and consequently on the rupee.
Omicron/Covid:
The year 2022 has started with the resurgence of fears linked to Covid and the new Omicron virus has affected most countries. In the United States, daily cases have risen to 10 lakh.
Also in India we have had daily cases of around 1-2 lakh. But, surprisingly, the virus caused fewer hospitalizations and fewer casualties.
One of the reasons for the same could be higher immunity as the public is now more experienced with the virus than before.
The second could be higher levels of vaccination of people.
And, thirdly, the virus could stay in the nose, causing fever, cough, cold sore but not reaching the lungs and therefore lower levels of hospitalization.
To date, Omicron/Covid has not caused major financial problems for most countries in the past 4 months as most governments have avoided lockdown.
A few restrictions are in place which could also be lifted if the number of cases starts to drop. Thus, the financial implications of the virus could be less, thus ensuring a normal life.
Inflation:
Inflation in the form of rising commodity prices has been a major headache for most central banks. Previously, central banks believed that inflation was transitory and therefore refrained from raising interest rates.
However, over the past four months, everyone expected inflation to last longer for the following reasons:
1. Commodity prices are rising and seem to continue to rise, especially energy prices.
2. Production of various items was unable to meet post-lockdown demand in April and May.
3. Chip shortages have led to shortages of items such as automobiles and electronics, increasing their costs.
4. Rising transportation costs have also kept inflation up.
All these factors do not go away in a short time and will keep inflation high. The FED realizing this started cutting $15 billion from December and doubled it to $30 billion in January.
The market started pricing in a rate hike in March-22 itself and another on June 22 and 2 more before December 22. The BOE has already carried out a rate hike of 15 bps, while the ECB and the BOJ have started to reduce their bond buying programs.
Interest rate:
India’s RBI has started absorbing cash since its last meeting. The stance was also hawkish (people calling it dovish normalization) despite its continued support for growth.
US 10-year yields rose above 1.80% and are expected to hit 2% shortly, while Indian yields rose to 6.59% from 6% earlier.
Thus, the tightening of yields speaks clearly to the interest positions in the future of the major central banks. With the advent of the new year, REITs selling stocks ceased and they became, to a small extent, net buyers.
Corporate inflows have been continuous, whether in the form of overseas RIL bond issues or any other inflow. Among asset classes, we know that bond yields have already tightened by around 50-60 basis points over the past 3-4 months and could tighten further to around 7%.
The Sensex has hit 60,000 again and is expected to increase further as it nears budget. After that, we have the IPO of LIC which would increase the market capitalization of Sensex.
So stocks look higher overall as the economy opens up and demand increases. Commodity prices, although in consolidation mode, still look higher.
However, gold prices appear to be consolidating as the FED raises interest rates. Gold prices in INR have been limited between Rs. 46,000 to Rs. 49,000 over the past year and are still looking to consolidate to lower.
In terms of currencies, European currencies look lower overall although they have consolidated over the past month.
The fundamental reason for the drop in European currencies is the rise in the dollar due to higher interest rates, with the US economy doing much better than most European economies. Asian currencies, especially the yuan, are generally higher, but those like the KRW have also weakened.
As for the USDINR, we saw 76.30 in December and now the Rupee is back at 73.80. The reason for the weakness was the higher trade deficit and US tapering.
The strength is due to capital inflows from businesses. The Rupee has alternated from weakness to strength each month over the past year and is expected to continue to do so over the coming months.
However, due to IPOs and a busy season, we should expect more inflows and hence more rupee strength. So we see a range of 73.50 to 75.50 that the Rupee has seen most of the time in 2021 over the next three months.
(Disclaimer: Opinions/suggestions/advice expressed here in this article are investment experts only. Zee Business suggests its readers consult their investment advisors before making any financial decisions.)