Federal Reserve interest rate hikes are not good news for the Indian stock market. The reason is because the Fed is trying to control domestic inflation. But it’s not clear how well this policy is working. And the employment sector, which depends on the Fed, may not benefit. So it’s possible that the central bank will reassess its accommodative policy in the near future. This could bring up the possibility of a short-covering rally in the markets.
Fed’s ultra-hawkish stance is the elephant in the room
The US Federal Reserve (Fed) announced a 0.5 percent hike in interest rates at its recent meeting. This will raise the Fed’s target rate to 4.25%-4.5 percent, up from 3.25-3.5 percent. However, the pace of rate hikes has sparked fears among investors.
This is the latest in a series of interest rate hikes by the Fed. It has raised rates three times so far in 2018.
In addition to raising rates, the Fed also announced a policy to begin rolling off its balance sheet. Although the Fed may still increase rates in the future, it will likely do so less frequently.
The move is an attempt to combat inflation, which has continued to surprise on the upside. In fact, September’s inflation was a full percentage point above the CB’s 2% target.
However, the move came amid soft consumer shopping data. And the pace of rate increases has already affected other investments, such as commodities. That’s why it’s important to monitor price dynamics.
Another risk is the possibility of a recession. Experts expect a bumpy start to the year. But a slowdown in rate hikes could lead to easier financial conditions.
If the economy does enter a recession, the Fed will be tempted to tighten monetary policy in order to protect inflation expectations. But that can also tamper with growth sooner.
The Fed’s ultra-hawkish stance has left investors confused. For instance, is the economy really headed for a recession? Does inflation have a chance of overshooting the Fed’s 2% target?
The answer is that it depends on a number of factors. However, the market is currently expecting a 75 basis point rate hike.
Fed’s interest rate hikes are a result of controlling domestic inflation
When the Federal Reserve Interest Rate Hike in July and September, they did so with the goal of controlling domestic inflation. They believe the additional rate hikes are necessary to reach their target of 2%.
Inflation is the result of a high demand for goods and services, and a shortage of supply. This supply-and-demand imbalance is a persistent problem in the U.S., and it is causing problems for both companies and consumers.
To keep prices in check, the Fed has increased interest rates, which is what the Fed calls the federal funds rate. Banks use this rate to borrow from other banks, and to pay interest on their own reserves. It has the benchmark rate used for other forms of consumer credit.
Because of the higher rate, borrowing will be more expensive for people. The Fed’s move to fight inflation will affect credit card borrowing, car loans, home mortgages, and more.
Higher interest rates will also mean that the value of the dollar will increase, making American goods more expensive in foreign markets. But this could slow the economy, too.
The next Fed meeting has set for November and December, and many experts are expecting a further rate hike. However, this time, the Fed may be more lenient.
The Fed’s most recent interest rate hike was its sixth in the last year. Previously, the Fed raised the rate by 0.75% in June, 1.5 percentage points in July, and half a point in August.
The increase had intended to combat white-hot inflation. Consumer prices have risen 8.2% in the past year.
Some analysts have predicted that the Fed will continue to raise rates until they get the price tag down. Others think it may be the beginning of a recession.
Fed’s interest rate hikes may not be working as desired for the employment sector
Fed Chair Jerome Powell has said that the central bank’s interest rate hikes may not be working as planned for the employment sector. The Federal Reserve has held the federal funds rate near its peak for as long as 18 months and has raised it twice in the past four meetings. But officials are wary of declaring victory too soon.
They believe the rate hikes have had little impact on the economy, and they may have depressed prices. Still, they are preparing to increase the rates in December.
Officials also pointed to a tight labor market. Wage growth is rising. Inflation has been higher than expected. But some lag indicators, like productivity, are lagging as well.
Some politicians have asked the Fed to slow down its rate increases. Ohio senator Sherrod Brown and Colorado senator John Hickenlooper have both written to Chairman Powell.
Many are afraid that the Fed could tip the economy into a recession. Traders may sell stocks or move into defensive investments as the FOMC announces a rate hike.
Higher borrowing costs will affect credit cards, auto loans, and business loans. It will also affect home values. As a result, the demand for housing has weakened.
The Fed may also change its target for GDP. It previously called for 1.2% growth in 2023.
This means that inflation has probably peaked, but could be headed down in the coming years. However, this does not mean that the economy is in recession. Rather, it indicates that the Fed is concerned that inflation is sticking and will have to be addressed before the rate increases have a significant effect on the economy.
Short-covering in India will lift markets
The Indian rupee has seen its biggest single-day gain in two months. This comes after the Reserve Bank of India (RBI) indicated it might change its accommodative stance to a more calibrated tightening at its upcoming policy meeting.
However, the Reserve Bank might not have spent $30 billion to defend the rupee. Instead, it might have focused on stabilizing the dollar, which has risen to three-week highs on a currency-versus-currency basis.
US markets have been a bit oversold on hawkish central bank stances. It has sent bond yields soaring and made stocks look like they had going to drop. Thankfully, today’s FOMC announcement has stabilized the markets and the dollar.
The move has expected to stimulate economic activity. Lower rates encourage consumers and businesses to spend. But, the Fed has also raised rates to combat the high inflation.
Today’s decision should give investors confidence that the Fed’s aggressive monetary policy is not only safe, but effective. In addition, the Fed has committed to maintaining its ultra-low interest rate for at least two more years.
Although the Fed has hinted at a slower pace of rate hikes, traders expect it to take seven to eight months before it raises rates again. That’s a little longer than the typical timeframe for a rate hike.
The Federal Reserve’s rate hike on Wednesday, 25 basis points, was the largest since 2006. However, it was the Fed’s pledge to continue with near-zero interest rates for at least the next two years that lifted global markets.
The move was accompanied by positive comments from Fed Chairman Jerome Powell. The Fed acknowledged that raising rates has been challenging for Americans, but it has also expected to slow inflation.
RBI may reassess its accommodative stance
The Reserve Bank of India (RBI) may reassess its accommodative stance on inflation and the growth outlook for the future. After hiking the repo rate by 40 basis points on May 4, 2022, the Monetary Policy Committee (MPC) met to review the evolution of growth-inflation dynamics.
The MPC retained the accommodative monetary policy stance. They also reaffirmed the MPC’s commitment to maintaining high levels of inflation targeting. This was despite a sharp spike in headline retail inflation in March.
The rise in inflation has driven by a variety of factors. Food and fuel prices have been above the RBI’s 2-6% ‘comfort zone’ for three months in a row. Additionally, the prolonged Russia-Ukraine crisis is boosting production costs and contributing to persistent inflation pressures. Moreover, a large sell-off in domestic bond markets has heightened redemption pressures.
The MPC’s decision to increase the repo rate has expected to support growth and help anchor inflation expectations. However, some economists have criticised the accommodative stance. In their opinion, the ratchet effect is not compatible with a sustained focus on inflation targeting.
According to the Citi analysts, the shock rate hike should be neutralized by the MPC’s commitment to a low-growth policy outlook. Furthermore, the rate hike is unlikely to have a material impact on the stock market, despite the withdrawal of excess accommodation.
In fact, the withdrawal of accommodation has expected to support growth. But the rate hike will draw down the liquidity in the banking system. As a result, banks will have less money to loan consumers. That said, the high quality private banks have the potential to expand.
On May 18, the MPC will announce the minutes of its meeting. While the decision was not unexpected, it was seen as necessary to address the volatility of the rupee and the threat of global inflation.