The Federal Reserve effected its fourth straight 75-basis-points hike on Wednesday, in line with market expectations, lifting the federal-funds rate to 3.75-4%. The Fed signalled smaller increases in future.
The S&P 500 slipped 2.5% and the Nasdaq Composite was down 3.4% on Wednesday as the Fed indicated that it had shifted its focus to how high to raise rates and how long to keep the monetary policy restrictive. Most of the Asian indices ended lower on Thursday, while European indices were trading in the red. Indian benchmarks Sensex and Nifty ended flat.
“The Fed may hike rates till 5% and then maintain a status quo depending on the data on inflation, jobless rate and spending. One will have to watch out for the unintended consequences of the rate hikes, though. We have already seen the policy misstep by the UK government which created problems for pension funds. A stronger dollar for longer will keep risk assets off the table, which could impact emerging markets such as India. Indian markets, however, may not fall as much as the others,” said Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies.
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According to UR Bhat, director at Alphaniti Fintech, the Fed did not indicate when it would stop with the hikes and this was seen as negative by markets worldwide. “As long as interest rate hikes continue, the outlook for emerging markets will continue to be dim. India, though, will be relatively better placed within EM basket.”
External facing sectors such as IT and pharma may continue to see headwinds.
“The IT sector will continue to follow negative cues from the US. And lower exports to the US and Europe may impact India’s balance of payments. Having said that, companies and governments are looking to diversify their supply chain away from China and India will be a beneficiary of that,” said Holland.
Over the past several years, global monetary policies, particularly those of the US Fed, have been the single-most important driver of equity markets globally, including India. “Currently, our US economists are forecasting the US GDP growth to slow to -0.2% in 2022 and to -0.8% in 2023. As a second order impact, slowing US and global growth would have ripple effects on India’s growth, especially for external facing sectors, and pose a risk to consensus earnings forecasts,” said Amish Shah, head of India research, BofA Securities.
‘Higher for longer’ would also mean that India will have to keep on increasing rates to ensure that interest differentials vis a vis the US are maintained, the foreign exchange rates are not impacted and there is an orderly deprecation of the rupee.
“We believe RBI will hike repo rate with 6.75% as fulcrum terminal rate. Given the dollar strength and our current account deficit situation, we do not think RBI would lower its guard or pause earlier, as that would create further speculative risks on the rupee,” said Akhil Mittal, senior fund manager, Tata Mutual Fund.
Mittal sees yields hardening by 15-25 bps over period of next couple of months. This would mean some possible MTM impact on investors in near term, but better accruals to existing and new investors once the yield move up.
“I think the Fed funds rate is headed toward 5.5%, and markets still need to absorb this across the yield curve. We will continue to face bouts of volatility like we have seen in the past few months on the back of each new data point as the yield curve adjusts to this scenario of a more hawkish Fed,” said Franklin Templeton fixed income CIO Sonal Desai.
