Why the US Fed’s last hike before a possible pause could mean good days for Indian markets

The BSE Sensex rose 556 points, or 0.91%, to end at 61,749.25 on Thursday following the Fed move.

What is the latest Fed hike hinting at?

From the language of the statement and the tone of the press conference of the US central bank, it seemed the Fed was trying to prepare the markets for a pause in June. Rates now seem to be in sufficiently restrictive territory. The Fed indicated it is likely to adopt a data-dependent, meeting-by-meeting approach and is not pre-committed to tightening aggressively from the current levels.

Fed Chair Jerome Powell said he saw moderate growth, and not recession, as the base case for the economy, while several members saw the US debt ceiling not being raised by the Congress as a potential risk. “The process of getting inflation down has a long way to go and below trend growth and indications of reducing inflation is what would cause the Fed to consider rate cuts. These remarks suggest that the Fed is indicating a high hold for a considerable time,” IFA Global Research said.

The Fed Chair noted that they “no longer anticipate” more rate hikes, while adding that no action could be “ruled out” if risks emerge.

Will this be the last hike?

From the market perspective, more important than the expected dovish rate hike is the Fed chief’s comment that “the case of avoiding a recession is more likely than having a recession.” Inflation in the US declined to 5% for the 12 months ended in March, down from 6% in February, the Bureau of Labour Statistics said last month.

Hemang Jani, head, equity strategy, broking & distribution, Motilal Oswal, said the Fed hike seems to be the last one, but rate cuts could happen only if there is significant deterioration in economic activity or inflation cools off.

Analysts have warned that more hikes will worsen the stress in consumer lending and lead to a rise in credit delinquencies. “It is our belief that this will be the final rate hike from the Fed this year, and there is a high probability that the Fed will begin reducing interest rates in the second half of 2023,” said Sunil Damania, Chief Investment Officer, MarketsMojo.

What are the challenges before the Fed?

Analysts said they preferred that the Fed not raise interest rates, given the current state of the banking industry in the US. After the collapse of Silicon Valley Bank and First Republic, PacWest Bank has run into difficulties. The recent rate hike is likely to complicate the situation. In addition, the US may face challenges in its commercial real estate market.

Further, reports from the US, the largest consumer market in the world, suggest that the consumer sentiment is weakening even at the higher income end, credit delinquencies are sharply higher, and there is risk of a steeper rise in unemployment.

What’s the impact on the Indian market?

Investors have viewed the Fed’s comments as a possible pause, and maybe even a pivot, in the next review. Madan Sabnavis, Chief Economist, Bank of Baroda, said there was a 52% chance of a rate cut in July. The latest Fed hike may not have a material impact on India as the RBI has paused hikes and there is weakness in the crude oil price.

Domestic markets are likely to remain resilient with limited volatility. The possibility of a soft landing for the US economy is positive for the IT segment, which has been on the backfoot over concerns of poor orders from the US. The strength of the rupee and the continued buying by foreign institutional investors (FIIs) will strengthen the market.

“High-frequency indicators in India reflect a resilient economy with improving earnings prospects. The sharp decline in crude is an extra bonus to the macro economy and benign for segments like paints, adhesives and tyres,” said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

If the Fed opts for a cut later in the year, capital inflows are expected to pick up. FIIs have already started investing in India, with inflows in April rising to Rs 13,545 crore and Rs 8,243 crore in May so far. If the Fed starts cutting rates from July 2023, markets are expected to rise sharply. The bottom line is: stay invested and accumulate stocks selectively.

What is the RBI up to?

The RBI is still awaiting the impact of its actions over the past 12 months, which is still playing out. The RBI has hiked the policy rate – Repo – by a cumulative 250 basis points to 6.5% since May 2022, which is still working through the system. Banks have hiked the lending and deposit rates. The RBI’s decision to pause in the April policy will give relief to borrowers as the external benchmark-based lending rate (EBLR), which is linked to Repo rate, will not increase. Lending rates will fall when inflation cools down.

With inflation likely to trend downwards from 5.66% in March as against 6.44% in February, there’s a perception in the market that the RBI is unlikely to go for rate hikes further in 2023.

While the central bank sees retail inflation easing to 5.2% in 2023-24, if inflation falls below 5%, the market can expect rate cuts, boosting sentiment.