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How you can make your portfolio immune to US Fed’s interest rate moves

When interest rates rise, they do place some downward pressure on asset prices

January 31, 2022 / 10:07 AM IST
The US Federal Reserve building

The US Federal Reserve building

Market participants across the globe are expecting the US Fed to hike rates this year, though they differ on the quantum and timing of such moves.

Inflation in the US and other developed nations have been much higher than the expectations of the central banks. Subsequently, interest rate increases and an eventual reduction in the Fed's asset holdings would follow as needed, while officials monitor how quickly inflation falls from current multi-decade highs back to the central bank’s two percent target, he added. Put simply, the era of cheap money is behind us.

Does that mean stocks will fall further?

FIIs have been cautious and have gradually cut their exposure to Indian stocks. FII holding in Nifty 500 stocks have already come down to a six-quarter low.  “After the lows of March 2020, Indian stocks have shown a relentless upmove and now we have seen a first meaningful correction,” says Sharad Chandra Shukla, Director, Mehta Equities. Though domestic money through direct investments by young investors and a healthy SIP book of mutual fund is coming to support stocks, the FIIs are not going to invest now. The markets are going to be volatile in near term, though in the long term Indian stocks should reward investors, he adds.

The rising interest rates in the US will ensure that large chunks of capital goes back to the US from emerging markets in a hurry, pulling down stock prices in many parts of the world including India.


Prasenjit Basu, Chief Economist, ICICI Securities expects a minimum of four hikes in the Fed Funds target rate in 2022, which will take the Fed Funds rate to 1.25 percent (from 0.125 percent currently). He sees Reserve Bank of India (RBI) to hike repo rate by 50 basis points in CY2022. “When interest rates rise, they do place some downward pressure on asset prices. In India, there will be a tussle between the strong prospects for EPS growth and the moderating influence of higher interest rates on equity valuations. Equity prices will rise more moderately in 2022 than they would have in the absence of rising policy rates,” he says.

When the interest rates are low (the money is almost free), the investors do not mind ascribing high valuations to the stocks. But when the interest rates rise, the opportunity cost also rises making investors shun high valuations stocks especially if they are not posting earnings growth. Over a medium term, if the stocks continue to post healthy earnings growth, then the investors do not mind holding on to such high-valued stocks and even in some cases add on to them.

Will bonds continue to disappoint?

The bond prices in India too are getting hit as the market forces start pricing in possible rate hikes in US as well as India. The benchmark 10 year bond yield has gone up to 6.74 percent compared to 6.24 percent as on October 1, 2021. Though central bankers in emerging markets are expected to follow the US Fed, the RBI may not follow soon. “The retail inflation- CPI is within the RBI MPC band of two to six percent. RBI has started squeezing surplus liquidity from the banking system through variable rate reverse repo auctions and already we have seen that there is a shift in the yield curve,” says Deepak Panjwani, Head-Debt Markets, GEPL Capital.

The RBI may not be in a hurry to raise rates just because the US Fed is planning to hike rates. “US Fed actions is one of the factors that influence the monetary policy of RBI. However, the RBI will consider many other factors such as domestic inflation, economic growth outlook, fiscal deficit, current account deficit etc, while deciding on the pace and quantum of rate hike,” says Joydeep Sen, Corporate Trainer-Debt.

The bond yields in India are rising and will have prominent adverse impact on the long tenured products. For example, Gilt funds with 10 year constant maturity has lost 0.54 percent in last three months ended January 25, 2022. As the crude oil prices touch USD 90 per barrel mark, the inflation concerns for India may not be going away soon. “We may see continued pressure on the bonds prices and slowly and gradually we may inched towards 7 percent,” says Panjwani. Forthcoming budget will be the key for the bond market as fiscal deficit and borrowing numbers will decide the stance of the RBI, he adds.

Gold: Do not shun it

Gold traditionally is seen as a safe haven investment and has lost 1.64 percent in last one year. “A rising global interest rate scenario is negative for gold prices,” says Sen. He is not alone. “Gold has an investment appeal when the investors are staring at uncertain future. Over next six months, the uncertainty will go down and gold may not remain attractive as a tactical call,” says Shukla. He advises holding on to gold in line with asset allocation but avoiding any aggressive investments in gold.

What should you do?

Investors should ideally stagger their investments in equities. Systematic investment plans in diversified equity funds and index funds work better. Among bond funds, it is better to remain invested in short duration schemes. Sticking to asset allocation can help deal with these current volatile times.

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Nikhil Walavalkar
Tags: #invest
first published: Jan 31, 2022 10:07 am
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