Oil, Omicron, Inflation and Interest Rates - What next on assets

The three important factors, which would be affecting all asset classes in the near term, are how the oil prices behave, how the Omicron behaves, and how the inflation behaves thus affecting the interest rate scenario in the coming 3-4 months.

In 2021, oil prices have risen by nearly 55% after the fall into negative in 2020. Higher oil prices will keep inflation on higher level, keeping most Central Banks in a hawkish mood.

In fact, the gas prices, higher carbon prices, and OPEC ensuring that production increase is not much will ensure that the oil prices stay higher for a longer period of time.

We spoke to Anil Kumar Bhansali, Head of Treasury, Finrex Treasury Advisors on how Oil, Omicron, Inflation will impact interest rates in 2022:

Oil:

Oil is India’s major import and every $10 increase in oil prices increases our CAD (Current account Deficit) by $14 billion and widens CAD/GDP ratio by 0.5%.

Till Dec-2021, our exports had gone up to $300 billion and is expected to cross $400 billion by March 2022. However, a part of the incremental exports has also been due to increased inflation and higher freight prices.

Our imports have risen dramatically taking the current account to negative in September and further negative is expected in December and March.

The monthly trade deficit in the past 4 months has risen to $22 billion. In the coming months, most analysts expect oil prices to rise past $100 per barrel as demand outstrips supply. This would surely put pressure on our current account and accordingly on the rupee.

Omicron/Covid:

The year 2022 started with Covid fears rising again and the new virus Omicron affected most countries. In the US, the daily cases have risen to 10 lakh.

In India also, we have had daily cases of about 1-2 lakh. But, surprisingly the virus has been causing fewer hospitalisations and lower casualties.

One of the reasons for the same could be higher immunity as the public now is more experienced with the virus than before.

The second could be higher levels of vaccination of people. 

And, third could be that the virus stays in the nose causing fever, cough, cold aches but does not travel to the lungs and therefore lower levels of hospitalization requirements.

Omicron/Covid has to date not caused serious financial trouble for most countries in the last 4 months as most Governments have avoided Lockdown.

A few restrictions are in place which could also get lifted if the number of cases starts coming down. So, the financial implications of the virus could be lower thus ensuring a normal life.

Inflation:

Inflation in the form of higher commodity prices has been a major headache for most Central Banks. Earlier the Central Banks thought that the inflation was transitory and therefore refrained from raising interest rates.

However, in the past four months all of them expected that the inflation is going to last for a longer period of time due to the following reasons:

1. The commodity prices are rising and look like will keep rising particularly the prices of Energy.

2. The production of various items has not been able to match the demand which has come after the lockdown in April and May.

3. Chips shortages have kept items like Automobiles, Electronics in short supply thus increasing their costs.

4. The increased freight costs have also kept inflation on the higher side.

All these factors are not going away in a short period of time and will keep inflation high. The FED having realized this started tapering $15 billion from December and doubled it to $30 billion in January.

The market started factoring in one rate hike in March-22 itself and another one June-22 and 2 more before Dec-22. BOE has already made one rate hike of 15 BPS, while ECB and BOJ have started lessening their bond-buying programmes.

Interest Rates:

India’s RBI has started absorbing liquidity from its last meeting. The stance was also hawkish (people calling it dovish normalization) despite its support to growth continuing.

The 10-year US Yields have risen beyond 1.80% and are expected to touch 2% shortly while the India yields have gone to 6.59% from 6% earlier.

Thus, the hardening of yields clearly speaks on the interest stances in the future of Major Central Banks. With the advent of the New Year, the FPIs selling in equities has stopped and they have turned net buyers to a small extent.

Corporate inflows have been continuous, whether it is in the form of RIL overseas bond issue or any other inflow. Amongst the asset classes, we know that the Bond Yields have already hardened by about 50-60 bps in the last 3-4 months and may harden further to about 7%.

The Sensex has touched 60,000 again and is expected to rise further as we approach the budget. After this, we have the LIC IPO which would take the Sensex market cap higher.

So, equities look higher overall as the economy opens and demand goes up. Commodity prices though look in consolidation mode still look higher.

However, gold prices look to consolidate as FED raises interest rates. The Gold prices in INR terms have been range-bound between Rs. 46000 to Rs. 49000 in the past one year and still looking to consolidate to lower.

In respect of currencies, European Currencies overall look lower though they have been consolidating in the past 1 month.

The Fundamental reason for the downside of European currencies is the upside in the dollar due to a hike in interest rates as the US economy is doing much better than most European Economies. Asian Currencies particularly the Yuan are generally higher but ones like KRW have weakened too.

In respect of USDINR, we have seen 76.30 in December and now the Rupee has clawed back to 73.80 levels. The reason for weakness was the higher trade deficit and US tapering.

The strength is on account of inflows from corporates. The rupee has been alternating from weakness to strength every month for the past year and is expected to continue to do so in the next few months.

However, due to the IPOs and a busy season, we should expect more inflows and therefore, more strength in the rupee. So, we see a range of 73.50 to 75.50 which the rupee has seen for most of the time in 2021in the coming three months.

(Disclaimer: The views/suggestions/advices expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)