The recent hike in the benchmark interest rate by the US Federal Reserve has rattled Foreign Portfolio Investors (FPIs) who were heavily invested in Indian index derivatives, reaching near-record high levels. These investors, who had been holding bullish positions in index futures contracts (Nifty and Bank Nifty), swiftly cut their positions to a mere fraction after the Fed’s rate hike announcement on Wednesday.
Their move to square off leveraged bets had a significant impact on the Nifty index, causing it to correct from a record high of 19991.85 on 20th July to 19753.8 on 31st July. When FPIs close out their long positions, they have to sell the contracts, leading to additional selling pressure in the market.
The cumulative holding of FPIs in index futures had reached a four-year high of 104,328 net long positions on 20th July. However, this position drastically reduced to just 5,667 contracts on 31st July. The last time FPIs held a larger position of 126,827 contracts was in April 2019. The process of reducing their positions started ahead of the rate decision on 26th July and gathered pace thereafter.
The rate hike by the US Federal Reserve, known as the Fed Funds Rate hike, increases the cost of funds for all greenback borrowers. This tends to drive hot money flows out of emerging markets like India and leads to the squaring off of hedges as the cost of hedging increases. Despite FPI inflows into cash stocks continuing with a net investment of ₹46,618 crore in the entire month of July, post the rate hike decision, FPI cash buying has slowed down with net sales of ₹1,250 crore on 28th July and ₹774 crore on 31st July.
On the day following the rate hike, FPIs cut over 50,000 contracts upon the expiry of the July series of futures and options (F&O) contracts. Each monthly series of F&O contracts expires on the last Thursday of the month.
According to UR Bhat, co-founder of Alphaniti, an advisory firm for Indian and US clients, FPIs chose to let their contracts expire rather than rolling them over due to the increased cost of holding leveraged bets resulting from the rate hike. He expects FPIs to resume F&O activity once expectations on US interest rates stabilize.
The Fed Funds Rate has risen significantly from 0-0.25% in March 2022 to 5.25-5.50% in July 2023, the highest in 22 years, in an attempt to tame spiraling inflation. The Fed chair, Jerome Powell, has indicated that more rate hikes could be on the horizon.
While the unwinding of leveraged bets from four-year highs was a consequence of the US interest rate rise, market experts like Rohit Srivastava, founder of analytics firm IndiaCharts, believe that this itself indicates that markets could rally again once FPIs reevaluate and resume their buying activities.
