InvestorQ : What is your view on the Fed policy outcome and do you see the impact of the same on Indian markets?
vidhya Laxmi made post

What is your view on the Fed policy outcome and do you see the impact of the same on Indian markets?

sarah Leo answered.
1 year ago

Ahead of the Fed policy statement, the only real debate was whether the rate hike would be 50 bps or 75 bps. The question was never about whether but by how much. Eventually, the Fed decided to hike the rates by 75 basis points. How much does this actually add up to on an effective basis. Fed has now raised rates by 25 bps in March, 50 bps in May and another 75 bps in June 2022. In short, the Fed has hiked rates by 150 bps in this cycle. During this period the upper end of the rate range spiked from 0.25% to 1.75%.

One clear message that came from the Fed this time is that there is going to be an aggressive front-ending of rate hikes. The December 2022 target for rates which was set at 3% in May 2022 has now been upped to 3.5%. The eventual target by the middle of 2023, which was 3.5% now stands enhanced to 4.25%. The Fed did feel constrained after the consumer inflation in the US had spiked to a 40-year high of 8.6%. After all, it is inflation that does impact the most susceptible segments of the economy.

The gist of the statement was that the Fed is now unambiguously focused on inflation control. These are special times and call for special actions. The 75 bps hike is the first time in the last 28 years because such a large rate hike was last undertaken by the Fed in 1994. Now Fed is positive that due to the hawkish approach of the Fed, the inflation is likely to fall sharply to 4.3% by December 2022, 2.7% by December 2023 and to 2.3% by December 2024. However, this is assuming that things go without creating a recession.

There were 3 more important projections made by the US Fed. Firstly, it is starting with the bond unwinding in the month of June at the rate of $47.5 billion per month, to be scaled up to $95 billion by September. Secondly, the Fed projects that this hawkish strategy would push the unemployment levels from 3.5% to 3.7% by December 2022, but that would still be classified as full employment. Thirdly and more significantly, Fed has projected that the interest hike strategy would depress the GDP growth from 2.8% to 1.7% in 2023.

Let me finally address what it means for India. Firstly, what happens to risk off flows with US rates going up. To an extent, RBI has also hiked rates and US inflation is higher. So, that is not much of a problem. Secondly, liquidity could be an issue but with $28 billion having already flowed out of India since October 2021 and rupee weakening to 78/$, the worst may be over. Lastly, the big challenge for the Indian economy is that a recession has to be avoided at all costs and that is still the X-factor at this point of time.