Reasons for the Fed rate hike
The US Federal Reserve Bank increased the policy rate from 3-3.25% by 75 bps to 3.25-4%. The Federal Reserve Chairman, Mr. Jerome Powell announced that the primary aim of the Fed would be to bring inflation in the US down to 2% and the restrictive policy will be retained until that objective is reached alongside other favourable financial assessments. The news was followed by major falls in the US indices like NASDAQ, S&P 500 and Dow Jones Industrial Average.
This policy rate hike comes even when the real GDP growth in the US has been low – this is because the inflation rate is extremely high, standing at 8.2% in the 12 months ending in September 2022. The imbalance in the US labour market due to excess demand and the supply constraints due to the Ukraine conflict have been cited as causes of the inflation among others. Therefore, this is the fourth time that the US Fed has raised the policy rate by 75 bps in recent months.
Time Snapshot of Fed rate hikes
|Date||Fed Rate Hike|
|16th March, 2022||25 bps|
|4th May, 2022||50 bps|
|15th June, 2022||75 bps|
|27th July, 2022||75 bps|
|21st September, 2022||75 bps|
|2nd Nov, 2022||75 bps|
Impact on the Indian markets
The first impact that we will discuss is the one on the Indian rupee. As US interest rates are rising, there is a depreciation of the Indian rupee every once in a while – some rate hikes get no reaction while some result in a 3.5% depreciation of the rupee. This is because firstly, American and other foreign investors (generally FIIs or Foreign Institutional Investors) would rather invest in bonds in the US market with higher interest rate and secondly, these FIIs can borrow less money from the US market in order to invest in India – therefore the flow of funds into Indian equity could sink. Consequently, the supply of US dollars can reduce and the rupee will depreciate.
Both Nifty and Sensex witnessed an overall drop – though the amount was low (0.11% for sensex and 0.17% for Nifty on 3rd November). The Indian rupee closed at a more depreciated level on 3rd November than the previous day’s close.
However, this impact is not too worrying. In fact, this negative impact on foreign investment will be offset by the following four factors –
- The rise in US Fed policy rates was expected by experts already and there were still no major withdrawals of funds by FIIs lately. Therefore, the actual announcement of the rate hike is unlikely to cause any additional stir among FIIs.
- Earlier when there had been significant selling among FIIs, the Domestic Institutional investors had bought them up allowing the Indian market to stabilise.
- Indian equity markets did not see any dips on the earlier occasions when the rate hikes of 75 bps were introduced. Therefore, the Indian market can be described to be on a rather independent trajectory of its own. GST collections, fuel consumption etc. have been healthy throughout.
- Even if the rupee depreciates, it may not be such bad news. Depreciation of the Indian rupee should actually help raise exports from India, thereby bringing in greater revenue for Indian domestic producers.
Therefore, it seems that the positive economic activity will most probably overcome the negative effects of the US policy rate hike.
The Way Forward
The US Federal Open Market Committee (FOMC) may have overdone its aggressive contractionary monetary policy in order to curb the temporary high inflation – therefore, although in the short run, it may keep hiking the rate (albeit by lower increments), eventually it will come to correct the stance, perhaps next year. Therefore, there is not much to worry about for the Indian investor when it comes to the US policy rates. The RBI itself might feel comfortable to raise interest rates in the coming months.