Fed Increases Interest Rates By 25 bps
The Federal Reserve raised interest rates by a quarter percentage point and signalled hikes at all six remaining meetings this year, launching a campaign to tackle the fastest inflation in four decades even as risks to economic growth mount.
To support growth, the US Federal Reserve has kept the interest rate near zero since the beginning of the Covid-19 pandemic two years back. Meanwhile, inflation in the United States skyrocketed to a four-decade high. The retail inflation touched 7.9 per cent in February, first time since 1982. The deadly waves of coronavirus pandemic disrupted the supply chains and pushed the prices of natural gas and other essential commodities. Moreover, Russian invasion of Ukraine recently shot up the crude oil prices to $140 per barrel, highest in 14 years. Amid the geo-political uncertainty, Federal Reserve decided to hike rates to raise borrowing costs enough to slow growth and tame high inflation.
An interest rate hike in the US results in outflow of funds from emerging markets and into US treasury bonds. The outflow weakens the equity markets and leads to a correction. As this Fed move was anticipated, FPIs had been liquidating their holdings from Indian equities in the last three or four months, leading to weakness and correction in Indian benchmark indices. Experts feel that the FPIs, having already pulled out funds in anticipation of rate hike, are unlikely to go for a knee-jerk reaction now. On Thursday, FPIs made a net investment Rs 2,800 crore, indicating that their selling has abated for the time being. On the other hand, the possibility of a truce between Russia and Ukraine, decline in unemployment rates in the US and better growth expectations could be beneficial for equity markets in the medium term and FPIs may start coming back in a few months.
The Fed’s decision to hike rates and rising domestic retail inflation rate will have a direct bearing on the Reserve Bank of India’s monetary policy review at the next meeting of the Monetary Policy Committee scheduled between April 6 and April 8. Unlike the US Fed, which has clearly reversed course from its accommodative monetary policy, the RBI continues to hold an accommodative stance. This is partly because the retail inflation in India has not breached the set target range of the RBI. On the other hand, if they act too little and too late, they may be blamed for “falling behind the curve” and may have a lot of catching up to do later, which will be detrimental to growth.
The Fed is not alone in turning more hawkish. The European Central Bank last week made a surprise announcement that it would be more aggressive in paring back bond-buying. The Bank of England is also set to lift rates on Thursday for a third straight meeting, while Brazil’s central bank is predicted to hike by another 100 basis points on Wednesday.
Going forward, Indian and global markets are expected to stay positive as three major uncertainties seem to be over — the Assembly elections in five Indian states, the US Fed’s decision, and signs of the Russia-Ukraine entering a resolution phase. Any spike in commodity prices could cause corrections in equity markets, even as the broader trend of rising stock prices remains intact. Investors need to remain wary of the volatility in the market and a void aggressive lumpsum investments. It is better to go through a systematic investment plan (SIP), and into well-established blue-chip companies and large- cap funds. Global markets, including India, have been very volatile in 2022 so far. Experts say that while investors should not expect returns of the kind seen in the second half of 2020 and through 2021, they should enter the markets with at least a three-year horizon.