Explained: Federal Reserve Signals and Indian Markets

The Dow Jones Industrial Index in the United States fell 0.77% and yields on Treasuries rose on Wednesday after the Federal Reserve said there could be two rate hikes by 2023. In India, the benchmark Sensex fell slightly and the rupee lost more than 1% against the dollar on Thursday. While the Fed changed its stance based on the progress of the economic recovery and the inflation situation in the United States, in India as well, concerns about inflation have increased.

Inflation based on the Wholesale Price Index (WPI) hit a record high of 12.94% in May, driven by higher fuel and commodity prices, and a weak base effect. It also translated into retail sales inflation of 6.30% in May – a six-month high that exceeded the Reserve Bank of India’s 4 ± 2% inflation target. While it remains to be seen how the RBI reacts, market participants believe that if inflation is accompanied by a rebound in the economy, it should not be of great concern to investors.

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What did the Federal Reserve say?

While maintaining they would maintain an accommodative monetary policy and bond buying program to support the economy, create jobs and achieve inflation of around 2%, Fed officials also discussed the hike. rates and a possible reduction, or decrease, in central bank bond purchases. program.

Contrary to what it said in March, the Fed signaled there could be at least two rate hikes by 2023 as indicators of economic activity strengthened and inflation strengthened . Some members were also in favor of a rate hike at least once in 2022. In March, the Fed signaled that it would keep rates close to zero until 2023.

In its statement on Wednesday, the Fed said it “is committed to using its full range of tools to support the US economy during this difficult time … Advances in vaccination have reduced the spread of Covid- 19 in the United States. Amid this progress and strong political support, economic activity and employment indicators have strengthened. “

Federal Reserve Chairman Jerome Powell in Washington. (AP Photo / Susan Walsh, Pool, File)

How did the markets react?

A rise in interest rates in the United States is impacting the debt and equity markets, not only in the United States, but also in emerging economies such as India which have recorded foreign portfolio investment (FPI) record over the past year.

After the Fed signaled, the Dow Jones Industrial fell 265 points and the Treasury yield fell from 1.498% on Tuesday to 1.569% on Wednesday. In India, the benchmark Sensex lost 461 points or 0.87% on the day before recovering to close at 52,323 on Thursday, a decline of 0.34%. The rupee lost 75 paisa or 1% against the dollar on Thursday to close at 74.08.

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What could be the impact of an anticipated rise in interest rates?

The Fed’s indication of an earlier-than-expected interest rate hike resulted in higher bond yields and a stronger dollar. At the same time, it has an impact on the currencies and stock markets of emerging economies.

The announcement of an interest rate hike in the United States not only results in an outflow from equities to US Treasury bonds, but also an outflow from emerging economies to the United States. Experts say that a rise in yields leads to a situation where they start to compete with stocks, which has an impact on market movements. The rupee is also expected to come under pressure as the dollar strengthens.

But many believe that if the economic recovery is strong in the United States and India, the impact of rising interest rates in the United States and some inflation might not be of great concern.

If the Fed’s position in March brought relief and stability to the market as it has given them nearly two years, the change in position should leave the markets a little vigilant.

After June saw Rs 14,500 crore REIT inflows into Indian capital markets, it remains to be seen whether there is a slowdown in the pace of inflows in the weeks and months ahead.

What are the concerns related to domestic inflation?

Wholesale price inflation has been rising for the past five months and is expected to rise further as the impact of high crude prices and surging commodity prices takes hold.

For a large number of commodities, their world prices are now reflected in their domestic prices. For example, gasoline, diesel and LPG experienced inflation of 62.3%, 66.3% and 60.9%, respectively, in May 2021. The food inflation component for retail price inflation rose significantly to 5.01% in May from 1.96% the month before. Some of the things that pushed retail price inflation were fuel, which recorded inflation at 11.6% (the highest since March 2021), transportation and communications at 12.6%, oil food at 30.8% and legumes at 9.3%.

Should we expect it to stay high and what can the RBI do?

Rising global crude oil and commodity prices are expected to push WPI inflation further in the coming months. As most developed countries opt for monetary stimulus, global commodity prices are rising against the backdrop of anticipation of a global economic recovery. In India, the ebb of the second wave of the pandemic and the increase in the number of vaccinations have raised expectations for a recovery in demand and higher prices for raw materials.

It would also lead to higher retail price inflation, putting the central bank on a tightrope to balance growth-inflation dynamics. While the RBI is unlikely to change its accommodative stance or policy rate anytime soon, it remains to be seen how it will react to global interest rate developments. Meanwhile, as there is no more room for a rate cut by the RBI, all eyes are on the government for fiscal policy action to stimulate growth.

Should investors be worried?

While global cash flows have boosted Indian markets over the past year, experts say rising interest rates in the United States and shrinking the monthly bond buying program (currently $ 120 billion dollars / month) could have an impact on stock market movements. These factors, and rising domestic inflation, will be critical to the movement of stock markets alongside economic recovery and growth.

The level of recovery in the Indian economy as the RBI hikes interest rates – which may still take some time – will be critical. The timing and pace of US interest is increased and the reduction in the bond buying program will also be critical for stock markets in India, which could see a cash out after the announcement.

While the Fed’s hawkish tone has not gone well with equity investors around the world, the impact on Indian stock markets has not been too pronounced. Pankaj Pandey, head of research at ICICIdirect.com, said that while interest rates will be increased in the future, he doesn’t expect a knee-jerk reaction. “As inflation rises, the underlying (factor) driving it is the economic rebound in the United States and India. While the United States will give a warning before raising rates and gradually reducing the bond buying program, even in India, the RBI seeks to ignore inflation for a while. I don’t see it as a big downside to the market if the economy is doing well, ”Pandey said.

About Alma Ackerman

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