Fed minutes indicate rate hikes to continue for now

The 2-day Fed meeting concluded on 27th July and the minutes were published after 21 days on 17th of August. It may be recollected that the Fed has already hiked the Fed rates by 225 basis points in the last 4 meetings since March. Out of this 225 bps hike, 150 bps hike happened in the months of June and July. The underlying theme of the minutes is that the members of the FOMC are unhappy with the pace of fall in inflation. Since the meet was in July, the 60 bps fall in July inflation is not included; but that would not have mattered much.

While the Fed minutes point to further rate hikes scheduled in 2022, there is some change in the tonality as evidenced in the minutes of the Fed meet. It is apparent that the Fed will not relent on its fight against inflation. However, with the rates already at the neutral rate zone of 2.25% to 2.50%, the pace of rate hikes may be more calibrated and more data driven in future. Today, the Fed rates are still 600 basis points below the inflation while in the comparable early eighties period, the Fed rates were in double digits.

Fed is not changing its peak rate targets for now

One way to assess the trajectory of future rate hikes is through the CME Fedwatch. This measure captures probabilities of different rate levels based on the implied probabilities in the Fed futures trading. This is a fairly accurate estimate, as has been seen in the past. Most of the rate hikes will be front loaded in the year 2022. FOMC members expect rate hikes to be done by end of 2022 at around 3.75%. From that point, the expectation is that rates may not go up more than 25 bps. Rather, 2023 will be used to take corrective action, if needed.

There are 3 more Fed meetings to go in September, November and December this year. The Fedwatch is hinting at another 125 bps rate hike in 2022 taking the rates to the range of 3.50% to 3.75%. obviously, after 2 rate hikes of 75 bps in June and July, rate hikes for the rest of 2022 will be of lower intensity. The message from the Fed is that it would not be satisfied with anything less than 2% inflation, although that still look some time away. As of now it is not clear at what point, the Fed would choose between inflation and growth.

While the Fed is still sticking to its inflation target of 2%, they have agreed to be data driven in future. While members are willing to quickly go into restrictive zone, the consensus will be more calibrated. This is a pure entry street, where exit can be quite tough. Hence the Fed would be wary of going too aggressive, now that the rates will have to move from the neutral zone to the restrictive zone.  That has implications for GDP growth and for jobs.

What India will read from the US Fed minutes?

RBI may have already stolen the thunder by hiking rates by 40 bps in the special May policy meet. Subsequently, RBI hiked rates by 50 bps each in June and August. If Fed has been hawkish, RBI has not been neutral either; raising repo rates by 140 bps between May and July. That is not all. The RBI has also hiked the base rate of SDF by 40 basis points and the cash reserve ratio (CRR) by 50 bps. In short, the RBI has already curbed any flow advantage that the US markets may look to have. That is evident in FPI flows stabilizing in India.

How will RBI react to further rate hikes by the Fed? Remember, inflation reaction in India has almost been immediate. CPI inflation has fallen 108 bps in 3 months while WPI inflation fell 270 bps in last 2 months. Commodity prices may have tapered, but RBI hawkishness is also delivering the goods. If the Fed goes slow on rate hikes, it will be sentimentally positive for India. IMF has already identified India as the fastest growing large economy in 2022 and 2023. RBI would not want to fritter away that advantage with too much hawkishness.