What were the highlights of the Fed rate hike announcement and what does it mean for India?

On 21st of September, when the US Fed made its post meeting statement, the outcome was largely expected. However, what was not expected was that the Fed has continued to hold its very hawkish stance, despite the obvious impact on growth and the limited impact on consumer inflation from the series of rate hikes till date. Fed hiked rates by a full 75 basis points to the range of 3.00% to 3.25%. Here are some of the major highlights of the Fed announcement after the policy statement.

· Fed was emphatic that it would continue hiking rates targeting a terminal rate of 4.6% in 2023. While most of the hikes would be front-loaded in 2022 itself, market watchers now look at informal Fed interest rate targets of around 5%.

· The current interest rate range of 3.00% to 3.25% is the highest level seen since just before the financial crisis hit the world economy in 2008 forcing huge cuts. That is hardly surprising considering that inflation is as bad as it was in the early 1980s.

· The CME Fedwatch is now hinting at another 75 bps rate hike in November and possibly another 50 bps in December. That would take the rates to the range of 4.25% to 4.5% by the end of 2022. However, Fed has ruled out any rate cuts in 2023.

· According to the Fed chair, they would continue this hawkishness till the time inflation was brought down all the way to 2% on a sustainable basis. However, this is going to take longer than expected due to the strong labour data at 3.7%. Fed is betting on this jobless rat to spike to 4.4% next year, the first sign of demand compression.

· Fed cut its GDP growth estimates for the US by a full 150 basis points for 2022 from 1.7% to just 0.2% after 2 quarters of very tepid growth. Year 2023 could see growth improving to 1.8%. Jerome Powell has warned that a recession was entirely a possibility.

· Fed is currently unwinding the bond book by $95 billion each month and that is likely to lighten the balance sheet, although it would also mean a sharp crunch in liquidity, having a global impact on liquidity.

That is the gist of the Fed statement. Let us now turn to what this entire story means for the Indian economy. It is clear that the RBI may be now inclined to hike rates by another 50 basis points when it meets towards the end of September. This could be followed up with another rate hike in December. While it is tough to speculate on the quantum of rate hikes, the RBI would want to ensure that the yield differentials are not unfavourable to India. The new thinking is that the RBI may target 6.5% terminal repo rate, instead of 6%.

The immediate concern would be the impact of the bond buying and liquidity tightening on portfolio flows into India. In August 2022, the FPIs infused $6.44 billion into Indian equities with a lot of allocation coming from passive funds. As liquidity unwinds in the US, a lot of the easy passive flows could get impacted. That is the bigger risk that the Indian equity markets should be watchful of.