The recent count of global volatility has increased, which was fairly anticipated given the rising short-term interest rates at the start of the year. This is due to rising inflation resulting in bond yield to increase to a new 52-week high. S&P500 & Nasdaq100 corrected by 6 percent and 12 percent from the highs made on February 16. US market had a relief rally on Friday, after a rough week, with the hope of Fed meet. It will be tested again in the coming week and a lot will depend on what expectation is building up in the US market.
World inflation has been constantly rising as economic growth gathered furiously driven by pent-up demand. In the US, CPI rose to 1.4 percent from zero in the last eight months and is forecasted to reach the Fed target of 2 percent in 2022. Consequently, in the market, US 10-year bond yield has increased to a new high of 1.57 percent and is estimated that it can breach 2 percent by the end of December 2021. The interest rate is also increasing due to the rising level of debt in the economy post the pandemic. Total public debt in the US has increased to 127 percent in June 2020 compared to 107 percent in December 2019.
The sudden spike in market interest rate happened as we are nearing the Federal Reserve's 2-day policy meet, which will begin on March 16 and conclude on March 17. Currently, Fed's bank interest rate is at 25bps and it is not expected to be increased in 2021-22. The idea is to maintain a low interest rate, to increase deployment in the economy and investments. Fed has also been buying T-Bills and Mortgage papers from the market to increase the liquidity in the system. There is a low risk that this policy will be changed soon and impact the strength of the financial market.
But there is confusion in the market as noticed by the movement of short-term trends. The volatility increased nearing the Fed meeting because the market needs a confirmation of the long-term policy. Such a progressive economy may not require an accommodative policy going ahead. Reiteration is required from Fed that it will maintain the accommodative stance, supported by the fact that the current unemployment level in the US economy is still high, actual economy growth is below the pre-COVID level and inflation has to catch up to the long-term target. At the same time, what will IT do to curb the further rise in yield is also important to watch out for since the market's interest rate is floating which will impact the cost of capital, level of arbitrage and demand in the economy. Constant rise will also make debt papers more attractive compared to the expensive equity asset.
The market consolidation will stabilise if we have a confirmation from FED that this hike in the short-term interest rate and inflation will not impact their long-term view. Also, what additional measures will be announced to curb the increase in long-term 10-year yield will be watched by the market. But, if the commentary accepts that rebound in the economy is much better than forecast and a slowdown in quantitative easing will be done in the future, it will have a heavy impact on the market.
Be ready to bear the near-term impact. An anxious period of trading can be expected in the coming trading days, a lot will depend on what is building up in the US market. Buying at dips is a good strategy in an expensive and progressive market. Go more for value picks and identify based on peer analysis. Themes like green energy, divestment, PSUs, pharma, IT and chemicals will be buoyant, as evergreen ideas. Attempt to identify the likely beneficiaries from such games & reforms. We also forecast that quality mid, small & micro-caps will continue to benefit in the long-term, as they have started to benefit from the reopening of the economy. The market is counting on trust that Fed will address the issue with no hike in interest rate, maintain Quantitative easing (QE) and measures to curb yield.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.