What the start of US Fed’s rate hike cycle means and how it could impact India

The US Federal Reserve has raised its benchmark lending rate by 25 basis points, or 0.25%, and has said that more such hikes could be in the offing in 2022. In fact, the Fed has signalled hikes in all its six bi-monthly meetings through the year. This means there could be at least six rate hikes this year. 

This is the first time since 2018 that the US Fed has raised the benchmark interest rates, after holding them to near zero in a bid to cushion the impact of the Covid-19 pandemic on the world’s biggest economy. 

What do global analysts expect in the days to come?

Moody’s expects an aggressive tightening cycle. “This is going to be a pretty aggressive tightening cycle. I don’t know if the Fed is going to pull off a soft landing,” said Ryan Sweet, head of monetary policy research at Moody’s Analytics Inc. “It’s very clear the Fed is more than doubling down on addressing inflation.”

What did the Fed have to say on the Russia-Ukraine situation?

The Federal Open Market Committee said in its policy statement following the two-day meeting in Washington, the first held in person – rather than via videoconference – since the pandemic began that the invasion of Ukraine by Russia is “causing tremendous human and economic hardship”.

“The implications for the US economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity,” the FOMC said.

But is the US Fed the only major central bank taking a hawkish stance?

Not really. The Fed is not alone in turning more hawkish. The European Central Bank last week made a surprise announcement that it would be more aggressive in paring back bond-buying. The Bank of England is also set to lift rates on Thursday for a third straight meeting, while Brazil’s central bank is predicted to increase interest rates by another 100 basis points. 

What do Indian analysts make of the Fed’s hike?

VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services, says the Fed's projections of another six hikes this year is “hawkish”, and so the rally in markets with S&P 500 and Nasdaq posting 2.24% and 3.7% upmoves, respectively, was a bit unexpected.

“The explanation is that the market was oversold and the consequent short covering pushed indices higher. The market drew confidence from the Fed chief’s statement that the ‘American economy is very strong’," Vijayakumar was cited as saying in a report by the Mint newspaper. 

Niraj Kumar, Chief Investment Officer at Future Generali India Life Insurance, feels that with the Fed alluding that the economy is on a strong footing, the rate hike cycle will be navigated much better this time.

“From the Indian market's standpoint, while the impending Fed rate hike has already resulted in strong selling by FIIs in the last few months, the strong support by DIIs has to a great extent mitigated the impact of FII selling,” Kumar said. “We reckon the markets will take this rate hike cycle in its stride, as prospects remain strong despite the inflationary headwinds and will navigate from the unknown to known territory," he said.

How has the stock market in India reacted to the rate hike so far?

Higher interest rates in the US typically result in foreign investors pulling their money from emerging markets like India back to the US for safer, and more secure returns. This capital flight puts significant pressure on the Reserve Bank of India to hike interest rates in turn, or face the rupee weakening significantly against the dollar, which again would lead to imported inflation for India.

The Indian market was expected to react negatively to the hike, but for now, it seems to have absorbed it and taken it in its stride. The benchmark BSE Sensex was trading up nearly 1.9% following the hike, in a sign that the market may have already factored it in. 

However, analysts feel that an increase in rates will certainly lead to some divestment from riskier assets like commodities and equities, especially with global markets in turmoil due to Russia’s invasion of Ukraine. Regardless, more volatility is in store as markets adjust to the interest rates as well as future projections.