At its policy meeting on Wednesday, the US Federal Reserve followed the sentiment of the market and kept things as they were, but it did hint at the prospect of two additional rate increases this year to fight inflation. Major indexes experienced a decline as a result, including those in Indian markets, where the Sensex dropped by 0.49 percent, or 311 points, to 62,917.63 on Thursday.
Will the Fed’s interest rate change and its hawkish comments have an impact on India’s interest rates and markets?
Despite acknowledging that the impacts of their cumulative tightening have not yet been seen, Fed Chair Jerome Powell insisted on continuing with it. It’s becoming evident that the Fed is ready to halt growth if necessary in order to reduce inflation to its target level. The central bank gained time to examine the effects of the previous five percentage point boost on the economy, particularly on the inflation and labour market fronts, by taking a break on Wednesday after 10 straight policy tightenings.
“Although the script met our expectations, what shocked us was the Fed’s aggressive policy position moving forward, which anticipates another 50 basis point increase in policy rates before the end of this year.
The Fed has increased its projections for inflation and GDP while decreasing those for unemployment, which indicates that price pressures are looking sticky, the widely anticipated US recession has been delayed, and the labour markets are showing strength. According to these projections, the Fed now has more leeway and justification for tightening. Over the next few months, investors should be prepared for volatility and likely some price declines in gold. However, persistent inflation will preclude any significant price declines, according to Ghazal Jain, fund manager for alternative investments at Quantum AMC.
Some market participants, however, do not anticipate future rate increases. “We think the likelihood of more rate increases in 2023 is low. At 4%, US inflation is already lower than its interest rates of 5.25%. Unless there is a severe surprise on the inflation front, the Fed won’t need to adjust rates, according to Apurva Sheth, head of market perspectives and research at SAMCO Securities.
The expectation that there will be two more rate increases from the Fed this year strengthens the idea that interest rates will continue to rise for a considerable amount of time. “It is imperative to pay attention to the currency component if global interest rates rise further or even stay at their current levels. As a result, we do not expect the Reserve Bank of India to decrease interest rates anytime soon. Additionally, it is imperative to view current equity prices with great caution given the rising risks to earnings and the huge increase in the cost of capital, according to Kedar Kadam, director, listed investments, at Waterfield Advisors.
In its policy review from June, the RBI kept the repo rate, a key policy tool, at its current level of 6.50 percent. Since May 2022, the repo rate has increased by 250 basis points (bps), and the increase is currently taking effect.
While internal inflation statistics in India are suggesting a potential cooling off—retail inflation fell to 4.25 percent in May—uncertainties around the monsoon and a comparison of equities valuations with other emerging economies bring further dangers. “We anticipate an upward risk to domestic inflation, but time will only reveal the true extent,” Kadam said.
The benchmark Sensex on the BSE decreased by 0.5% on Thursday as a result of the Fed’s hint at additional rate increases. The news dampened Indian equity markets because an increase in US interest rates may cause some capital to leave emerging economies and move to US treasury bonds in addition to slowing inflows into Indian equities.