Fed’s decision in July will indicate the course of action going forward
There is a lot of attention on what the US Federal Reserve is doing, and rightfully so. To recap, it has hiked the overnight interest rate by 5 percentage points in the current hike cycle. The pandemic-period low interest rate was 0 to 0.25%; currently it is 5 to 5.25%. The question is, what is the expectation now, on further rate hikes.
Going by a recent statement by the US Fed chairman, there is a likelihood of two more rate hikes of 25 basis points each, totalling 0.5%. As per market assigned probability, the probability of the Fed rate being hiked by 25 basis points is very high. That is, it is almost a given that the rate will be hiked on that day. Question is, what is the market expecting thereafter? The FOMC meeting after July 26 is scheduled for September 20, 2023. Since it is sometime away, market expectation will be shaped by developments in the run-up to that date.
Easing inflation in the US
As per currently available data points, we have easing inflation in the US. CPI inflation for June 2023 eased to 3%. The implication is, the pressure on the US Fed to hike rates would be that much lower. That is, the early indication on the likelihood for the meeting on September 20, 2023 is soft.
There is an indicator called DXY, which is the Dollar index, measuring the strength of the US Dollar against a basket of six major global currencies. The index was at approx. 103.5 in the first week of July. Currently, as we write, it has eased to 100.6. The easing of the DXY shows that the market is looking at the end of the rate hike cycle, as softer interest rates in the US implies that much softer flow of funds into US investment assets. As per communication from the US Fed, as well as market expectations, there is probability of rate cuts by the FOMC in 2024.
What for us?
While global factors are relevant, it is not a make-or-break aspect. The differential between our repo rate at 6.5% and US Fed rate of 5 to 5.25% is lower than historical standards. After the potential rate hike on July 26, 2023, the differential would be even lower. There is a notion that this would put pressure on the RBI to hike repo rate. It is not so. The growth rate of our economy is the fastest among major countries in the world. Foreign portfolio investors (FPIs) are buying significantly in equity stocks this year.
Our markets do react to the US events and potential events, but that is a short-term phenomenon. Over the long term, markets are shaped by our fundamentals, not theirs. RBI’s interest rate decision-making parameters are our inflation, our GDP growth, our currency level, etc.
Globally, as well as in India, we are at or near the climax of the rate hike cycle. This is known to the markets. In the immediate term, the market will watch out for, and you also can keep your eyes on the outcome on July 26, 2023. It is not so much for the decision, as it is almost a given as per market outlook. It is about the hints for the course of action going forward.
Source: https://www.financialexpress.com/money/your-money-us-rate-hike-what-it-may-mean-for-us-3172790/