India could face a selloff if US federal reserve increases interest rates

MUMBAI: The word ‘patient’ and a few dots will determine the direction of the stock market in the near term. Investors are watching whether the US Federal Reserve omits the word ‘patient’ from its commentary on the interest rate outlook at the end of the two-day meeting on Wednesday.

The US central bank, while announcing its monetary policy decision, will release a set of economic forecasts including the widelywatched dot plot. The dot plot gives insight into what members of the rate-setting Federal Open Market Committee (FOMC) think about the direction of interest rates over the next one year.

In the last six months, bears have held back from an onslaught on the global markets because of the use of ‘patient’ in this line by the Fed: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalise the stance of monetary policy”.

Doing away with ‘patient’ will pave the way of interest rate increases soon, which, according to market watchers, could spark a sell-off in emerging markets including India. Prospects of a rate increase in the US would strengthen the dollar against various currencies including the rupee, resulting in lesser foreign institutional investor (FII) flows in stocks, and possibly outflows.

“The odds of Fed removing ‘patient’ from its statement has become higher. If that happens, the market’s reaction will be negative given the fact that markets have run up so much,” said Tirthankar Patnaik, chief strategist and head of research, India at Mizuho Bank. The Sensex has risen almost 30% in the last one year, led by strong FII inflows, making Indian stocks one of the best performers across emerging markets.

Investors will look for hints on whether Fed would raise rates in June or September based on a combination of whether the US central bank removes patient and the dot plot. The view of various FOMC members is plotted on a chart in the form of dots. The market gets a sense of FOMC members' forecasts on interest rates based on the placement of the dots on the chart.

“If the Fed removes the word ‘patient’ but keeps ‘dots’ where they are, it will likely be seen as hawkish by markets. Volatility will likely rise and emerging market related assets will likely suffer,” said Bertrand Delgado, senior EM strategist, HSBC Securities. Last week, emerging markets including India were dragged down following better-than-expected US jobs data.