Inflation surge could push the Fed into more than four rate hikes this year

Global developments

Cracks are beginning to appear in some risk assets on concerns around Fed tightening. The S&P500 has corrected 7.7% and Nasdaq has dropped 12% YTD. Tech-heavy Nasdaq had benefitted from low US yields. They are now coming under pressure with US yields inching higher. Stocks that had benefitted from the 'Stay at Home' theme are also now coming under pressure. On Friday the global risk sentiment had been marred by US-Russia geopolitical tensions around Ukraine. Despite a drop in US yields, equities still underperformed with S&P500 losing another 1.9%. From a high of 1.90% seen on 19th Jan, the US 10y yield dropped to a low of 1.73% on Friday. It has recovered today in the Asia session to 1.77%. Brent too which had dropped on higher than expected build-up in US inventories has recovered to get back to the highest level in 7 years at USD 88.5 per barrel. Gold continues to hold up amid a cautious risk tone. Bitcoin has dropped another 10% over the weekend to USD 35500. The focus this week will be on the Fed policy due late Wednesday evening. A section of the market is also expecting a 50bps rate hike by the Fed in March. We however believe the market is pricing at an extremely steep pace of hikes. By mere hawkish communication, the Fed has succeeded in bringing the long-term inflation expectations from 2.30% to 2.07%. The risk, therefore, is Fed may jeopardize recovery if inflation expectations drop further.

Domestic developments

Equities

The Nifty has dropped 4% from recent highs in 4 sessions. It has retraced 75% of the up move since December end from 17238 to 18350. We may see investors pare some risk ahead of key global and domestic risk events. 17450 is extremely crucial support on the Nifty.

Bonds and rates

The yield on the benchmark 10y ended 3bps higher at 6.63% on Friday. The 5y benchmark bond was partly devolved on PDs in Friday's auction. Traders are refraining from making fresh bets ahead of the union budget. 3y and 5y OIS ended 4bps lower on Friday at 5.30% and 5.62% respectively.

USD/INR

The Rupee traded a 74.40-74.55 range on Friday. The Yuan is continuing to strengthen and that may aid the Rupee as well. The RBI may become permissive of Rupee strength if Yuan strengthens. Asian currencies are stronger against the Dollar. 1y forward yield ended at 4.70% while 3m ATMF implied vols ended at 4.60% on Friday.

Strategy: Exporters are advised to cover on upticks towards 74.80 levels. Importers are advised to cover on dips towards 73.80 - 73.90 level. The 3M range for USDINR is 73.80 – 76.00 and the 6M range is 73.50 – 76.50.

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