Federal Reserve hikes rates again: what it means for Indian markets, investors

Fed move and outlook

The US central bank has said supply-demand imbalances are causing inflation. However, it only has the tools to control the demand side — which it is using to bring inflation in line with its mandate of 2%.

The Fed seems inclined to hold these rates for several quarters while it watches job openings come in line with unemployment, and the movement of GDP and the rate of inflation.

It would rather err on the side of over-tightening, leaving itself room to loosen later if required, than under-tighten, in which situation it could end up fighting an entrenched inflation level for a long time.

The Fed has said the battle against inflation would require borrowing costs to rise further, pointing to the fact that it may be nearing an inflection point in what has become the swiftest tightening of US monetary policy in 40 years. The pace may, however, be tempered in December and beyond.

Akhil Mittal, senior fund manager, Tata Mutual Fund, said: “The market was expecting a slightly dovish tone from the Fed…but the tone was not hawkish either. It might not deliver 75 bps moves going forward — however, the pivot might shift to 5% instead of 4.5%-5%.”

Will Fed hike nudge RBI?

It’s not necessary that the RBI will blindly follow the Fed and other central banks in raising rates. The RBI considers domestic factors, especially retail inflation, while reviewing the interest rates. However, high imported inflation has added to the retail inflation in India, and RBI has already raised the repo rate by 190 bps over the last six months.

The RBI’s Monetary Policy Committee met on Thursday to discuss its report to the government on its failure to meet the inflation target (4% plus/minus 2%) for three quarters in a row. Retail inflation accelerated to 7.41 per cent in September.

Bankers expect more rate hikes this year. “We expect another 60 bps hikes in this fiscal, driven by the need for price stability, to anchor inflationary expectations, and backstop rate differentials to support the currency. Into FY24, the policy committee is expected to draw a pause,” Radhika Rao, senior economist, DBS Bank, said.

Impact on Indian markets

Fed’s continuous rate hikes does not augur well for emerging markets including India. An increase in US interest rates results in an outflow of funds to US markets, putting their stock markets and currencies under pressure. Equity markets are likely to see increased volatility in the next few months.

While the Fed commentary after the 75 bps rate hike disappointed markets, when asked about moderating rate hikes, Fed Chair Jerome Powell said, “That time is coming and it may come as soon as the next meeting or the one after that.” Markets could bounce back, since the economy continues to be strong and unemployment is at record lows.

On the RBI’s likely stance, Mittal said: “Given the dollar’s 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 INR…. We think RBI will…tighten policy to levels where it is sure of meeting inflation targets… We see yields hardening by 15-25 bps over the next couple of months.”

What should investors do?

Analysts said leading indicators like credit growth, capital expenditure, and auto sales point to a robust economic recovery. As such, Indian retail investors should continue with their equity investments as the economic fundamentals remain sound, and would lead to outperformance in the equity asset class over the next three-five years. In equities, investors should ideally go with mutual funds; for direct investment, they should look at large cap stocks, especially in the banking, capital goods, and auto segment.

A fund manager said even foreign equity investors could look towards India. “While the rising interest rates represent headwinds for Indian equities, our buoyant domestic demand scenario presents hope for investors looking to diversify globally. We remain constructive on Indian equities over the medium term…,” the fund manager said.

Debt investors can expect interest rates to peak over the next quarter or so, which could provide an opportune time to lock in for a 3-5-year term.