Emerging market liquidity is set to dial back as major central banks of developed economies adjust their policies to tackle the post-Covid era.
The Federal Reserve, last week, announced that it would be aggressive on tapering bond purchases and announced several rate hikes in 2022.
The Bank of England, on the other hand, hiked interest rates for the first time since the start of the pandemic, citing a strong labor market and the need to return inflation towards its 2% target.
The European Central Bank struck a more dovish tone, further cutting its pandemic-era bond buying program but vowing to stay accommodative through 2022 and beyond.
This is in contrast to the Reserve Bank of India, which decided to keep its repo and reverse repo rate unchanged at the December policy meeting even though it expected inflationary pressure to persist in the near-term.
Analysts feel many emerging markets will be in an increasingly difficult spot, going-forward, as the current inflation shock could prove to be more permanent in developing economies than in the United States or Europe.
“If conditions persist, the US central bank may not only hike rates but also begin the process of allowing bonds that it holds to mature and/or selling bonds to reduce the size of its balance sheet. This scenario is not priced in the markets and will be a big scare for risk assets, especially in EMs, which have been a beneficiary of global liquidity,” says Arvind Chari, chief investment advisor, Quantum Advisors
Further, this gradual pullback in liquidity and easy money flow into EM equities will likely slow down their performance in 2022.
“Typically, the emerging markets (EMs) underperform their developed market (DM) peers in a scenario when interest rates in the developed world start to rise. Flows are directed towards DMs as FPIs have lack of interest in EMs,” says U R Bhat, cofounder and director, Alphaniti Fintech
This shows up in the recent FPI activity in the equity market as well. While the rupee has depreciated by around 1% in December so far, topping the 76/$-mark, FPIs have been net sellers of nearly $3 billion in the equity market in the first fortnight of the same month.
No wonder then that the BSE Sensex and the Nifty50 dropped 3% last week as India remains one of the richly valued emerging markets with a sticky inflation and a weaker currency.
For now, the benchmarks stand at 57,012 and 16,985 levels, respectively, and are expected to trade in a narrow range this week.
The 50-pack Nifty, for instance, is expected to trade within a range of 16,250 to 17,450, having support around 16,500 levels.
The Sensex, meanwhile, may remain within a band of 55,700 and 58,100.
On the global front, FII flows and news flow around the Omicron variant will be the key drivers for the markets this week, while domestically, initial public offers, new listings of Shriram Properties, MapmyIndia, Metro Brands, MedPlus Health and Data Patterns will guide the trajectory.
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