The Federal Reserve’s latest rate hike may have been largely anticipated by markets, but the implications for India go well beyond the 25-basis-point move. For Indian equities, the bigger transmission channels could be US bond yields, the dollar, crude oil and the rupee—and the way these four variables interact could determine the next leg for markets.
With US Treasury yields elevated, the dollar strengthening, crude prices adding pressure to India’s import bill and the rupee trading near record lows, global investors face a very different risk-reward equation when allocating capital to emerging markets. At the same time, higher US yields are making fixed income increasingly competitive with equities for global capital.
So, what does another potential Fed hike mean for FPI flows into India? How much room does the RBI have to pursue an independent monetary policy? And can strong domestic liquidity offset global headwinds?
In this episode of ETMarkets Smart Talk, Sachin Shah, Executive Director and Fund Manager at Emkay Investment Managers, decodes the four-way interaction between the Fed, dollar, crude and rupee—and explains what it could mean for Indian equities, capital flows and valuations. Edited Excerpts –
Q) The Fed has raised rates by 25 bps, but markets were largely expecting it. What does it mean for Indian markets?
A) The 25-basis-point hike itself is unlikely to be the biggest issue for Indian markets because it was substantially priced in. The more important signal is that the Fed has reopened the tightening cycle and its September projections point to the possibility of another increase this year.
The Fed raised the target range to 3.75–4.00%, while its median projection for the policy rate at end-2026 moved up to 4.1%. We therefore see the Fed move as an incremental headwind rather than a standalone trigger for a sharp correction. Indian equities have also become less dependent on foreign flows than they were a decade ago, with domestic capital providing a deeper counterbalance.
The key question now is whether the Fed’s action keeps US yields and the dollar elevated. That will influence foreign allocations, the rupee and ultimately the valuation multiple global investors are willing to pay for Indian equities.
The initial market reaction reflects this distinction: Indian benchmarks moved modestly higher on September 17 despite the Fed hike, although elevated oil prices and the prospect of further US tightening capped gains.
Q) For Indian equities, should investors be more worried about the Fed itself or the resulting move in US bond yields and the dollar?
A) We would focus more closely on US bond yields and the dollar than on the Fed rate decision in isolation. The Fed provides the policy impulse, but markets transmit that impulse through yields, currencies and liquidity.
A higher US Treasury yield raises the risk-free return available to a global investor. That increases the return hurdle for taking equity, emerging-market and currency risk in India. A stronger dollar adds another layer because it can pressure the rupee, raise imported costs and reduce dollar-adjusted returns for foreign investors.
That transmission mechanism is already visible. Following the Fed decision, the US two-year Treasury yield moved to around 4.72%, while the 10-year yield was around 5%. At the same time, the dollar strengthened and the rupee was trading close to the ₹96-per-dollar level.
This becomes particularly important for India when crude oil prices are elevated. A stronger dollar and expensive oil can work in the same direction: they increase the import bill, pressure the rupee and potentially add to domestic inflation.
So, for Indian equities, we would watch the US 10-year yield, the dollar, the rupee and crude oil together. The headline Fed decision matters, but these variables tell us how much of the Fed tightening reaches Indian financial conditions.
Q) If the Fed delivers another rate hike this year, what could that mean for global risk assets, emerging markets and capital flows?
A) Another 25-basis-point hike would not necessarily create the same degree of shock as an unexpected tightening because the Fed’s own projections already point towards another increase. The bigger issue would be what that hike says about the terminal rate and the persistence of US inflation.
A single additional hike accompanied by signs that the tightening cycle is approaching its peak could be relatively manageable. A continued upward repricing of rates would be more challenging. Higher US yields increase discount rates for equities, make financing more expensive and raise the opportunity cost of holding risk assets.
Emerging markets face an additional complication: currency risk. Higher US yields combined with a stronger dollar can encourage global investors to shift capital towards dollar assets, particularly when they can obtain attractive yields without taking emerging-market equity risk. We can already see evidence of this rotation.
In the week ended September 9, global equity funds saw $15.52 billion of net outflows, while bond funds attracted $8.95 billion. Emerging-market equity funds recorded $1.56 billion of withdrawals, while emerging-market bond funds continued to receive inflows.
That distinction is important. Higher US rates do not automatically mean capital exits every emerging-market asset. Investors can rotate between equities, sovereign debt and different geographies.
For India, earnings delivery, valuations, currency stability and domestic liquidity will therefore determine how much of the global tightening translates into FPI selling.
Q) What does the Fed’s latest move mean for the RBI? Does India have enough room to pursue an independent monetary policy?
A) The RBI does not have to mechanically follow the Federal Reserve. India runs a flexible inflation-targeting framework, so domestic inflation and growth remain the primary drivers of monetary policy. However, monetary-policy independence does not mean immunity from global financial conditions.
India's domestic backdrop has become somewhat more complicated. Consumer inflation rose to 4.82% in August from 4.45% in July, while core inflation also moved higher. The repo rate currently stands at 5.25%.
Higher crude prices, a weaker rupee and tighter global financial conditions can increase the risk that imported price pressures spread more broadly through the economy. That means the Fed's latest move probably reduces the RBI's flexibility at the margin.
It does not create an automatic case for an RBI hike, but it makes aggressive policy divergence more difficult if that divergence begins to amplify currency depreciation or inflation.
India also has meaningful buffers. Foreign-exchange reserves recently reached a record $785.7 billion, giving the RBI substantial capacity to smooth disorderly currency movements.
We would therefore characterise India’s position as one of meaningful, but constrained, monetary-policy independence. The RBI can respond to India's own economic cycle, but the room for divergence narrows when US yields, the dollar, crude oil and domestic inflation all move in the same adverse direction.
Q) Does a higher-rate environment make US fixed income more compelling for global investors compared with the previous decade of ultra-low yields?
A) Yes, the relative attractiveness of US fixed income has changed materially. The most important difference is the starting yield. With the two-year US Treasury yielding around 4.7% and the 10-year close to 5%, investors can earn meaningful nominal income from high-quality government securities without assuming equity-market risk.
That was very different from much of the post-global-financial-crisis period, when extremely low policy rates pushed investors further along the risk curve in search of returns. Today, fixed income can compete directly with equities, emerging markets and credit for global capital.
This also helps explain why high US yields matter so much for India. An international investor comparing a near-5% US Treasury yield with Indian equities has a much higher opportunity cost than during the ultra-low-rate era. Indian assets therefore need to compensate through stronger earnings growth, attractive valuations or currency-adjusted returns.
We are already seeing some evidence of this allocation shift: global bond funds attracted nearly $9 billion in the week to September 9 even as global equity funds experienced sizeable withdrawals. Short-duration bond funds alone attracted $6.65 billion. The qualification is duration risk.
High starting yields make fixed income more attractive, but long-dated Treasury prices can still fall materially if yields rise further. So the structural change is not that bonds have become risk-free investments; it is that US fixed income once again offers enough income to compete seriously for global capital.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times.)
