What Fed rate hike indicates, what investors should do now

Experts said that the Fed’s decision indicates more rate hikes by the RBI going forward and, therefore, further increases in EMIs and deposit rates, and subdued equity market returns for now.

What does the Fed’s hike indicate?

According to IFA Global, the hike was expected — as a pause would have indicated a lack of confidence in the measures taken to address the troubles in the banking system.

The policy statement said the Fed remains committed to achieving its inflation mandate. It has followed the same playbook as the European Central Bank (ECB): separating its financial stability mandate from the price stability mandate.

Fed Chair Jerome Powell also indicated that even higher interest rates could be coming as inflation remained hotter than expected. Fed officials expect at least one more rate hike this year, according to projections released on Wednesday. “If we need to raise rates higher, we will,” Powell said.

He said the financial sector was “sound and resilient”. There had been speculation that the Fed might go slow on rate hikes and follow a loose monetary policy to bring the banking system back on the rails, as analysts had blamed the flurry of rate hikes in the last 10 months for the banking crisis.

Will the RBI hike as well?

When the Fed is tightening, interest rates tend to rise more for emerging markets, including India, which see a sharp currency depreciation. “Fed action is due to large excess demand, tight labour markets and an unprecedented deviation from the inflation target. India does not have these conditions and has the space not to follow the Fed. It also started from higher nominal policy rates,” Ashima Goyal, Member, Monetary Policy Committee of the RBI, said in the minutes of the policy meeting discussions.

While it is not necessary that the RBI will blindly follow the Fed and other central banks in hiking rates, interest rates in India have, in fact, moved in tandem with rates in the US. While most central banks, including the RBI, have been raising rates to tame inflation, the RBI considers domestic factors, especially retail inflation, while reviewing interest rates. As price pressures wane, several central banks have opted for slower rate hikes or pauses.

After the 250 bps hike in the repo rate to 6.50% over the last 10 months, the RBI’s Monetary Policy Committee (MPC) will meet on April 3-6 to decide its strategy.

“With the headline CPI print tracking above 6% mark for January and February, we build in an additional rate hike of 25 bps by the RBI in its April policy review, as we peg the terminal rate at 6.75%. Further, in our view, the inflation trajectory is likely to decelerate from QE June, which will preempt the RBI to pause the rate hike cycle,” Morgan Stanley said in a report.

However, Nomura expects the RBI to remain on hold in April owing to the benign forward inflation profile, lagged monetary policy effects, worsening US financial/ economic outlooks and weaker domestic demand outlook in FY24. “We assign a higher probability to a pause (80%) than to a 25 bps hike (20%),” Nomura said.

What does the Fed hike mean for investors?

When interest rates rise in the US and other developed markets, foreign investors, especially from the US, go for investments in US debt and other avenues, which impacts the flow of funds into Indian equity markets. Since the beginning of January 2023, foreign portfolio investors (FPIs) have pulled out a net of more than Rs 27,000 crore from Indian equities.

“While the rising interest rates represent a headwind for Indian equities, our buoyant domestic demand scenario presents hope for global investors looking to diversify globally. We remain constructive on Indian equities over the medium term and continue to orient our portfolios around domestic cyclical which continue to look attractive in the medium term,” a fund manager said.

Over the past year, FPI flows saw bouts of revival but the momentum has flagged amidst a domestic stock market rout, exacerbated by the Fed’s fight against inflation, and the reopening in China. FPI flows are important to India as they help to meet funding requirements caused by a growing current account deficit, says a Bank of Baroda report.

“Since risk off is the dominant market mood following the bank failures in the US and fears of contagion, FPIs are unlikely to turn buyers in the near term,” V K Vijayakumar, chief investment strategist, Geojit Financial Services, said.

As for debt investors, as interest rates are expected to rise further before stabilising and moving on a downward trajectory, investment advisors say they should look to invest in medium- to long-term debt investment products as interest rates peak in the coming months.