When the US Federal Reserve meeting concluded on Wednesday, there was little by way of surprise as the 25 basis points hike was already factored in. The debate was more over whether the Fed would guide for 3 rate hikes or 4 rate hikes during the calendar year 2018. With this hike, the Fed has hiked the Fed Funds rate by 150 basis points since the beginning of 2016. The chart below captures the trajectory of the Fed Funds rate.
Effectively, the Fed Funds rate has moved up from the range of 0.00-0.25% in the beginning of 2016 to the range of 1.50-1.75% after the latest rate hike. The policy was also significant as it was the first policy announced by Fed Chief Jerome Powell after taking over from Janet Yellen. So, what were the key justifications for the 25 basis points rate hike?
The US Fed has given the following justifications for the hike in Fed rate by 25 basis points in its March Fed meet…
The interesting statement of the Fed is that it has agreed to keep liquidity accommodative even while maintaining the upward trajectory of the Fed Fund rates. That means in terms of tapering of the liquidity in the form sale of bonds may not happen aggressively for now. On the economic projections front, the US Fed is projecting higher inflation higher levels of employment but lower levels of GDP growth. But the overall Fed funds trajectory is now likely to go beyond the original target fund rates. Let us look at the specifics of the Fed forecast.
If the Fed opts for 4 rate hikes instead of 3 rate hikes then it is likely to be negative for the Indian markets. It could also mean that the RBI may have to look at a possible hike in repo rates to ensure that the yield differential is maintained and India does not suffer debt portfolio outflows. It has been seen in the past that any rate hike by the US Fed has been negative in the short run but positive for India markets in the medium to long run and hence rates may not be the issue. That is because rate hikes by the US are a signal that the US economy is growing. The real issue for India to contend will be what happens to the trade war between the US, EU and China. If retaliation becomes the theme then we could see a spiralling of trade wars and currency wars. That could be much worse than Fed hikes. That is what Indian markets need to actually prepare for!
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