Ahead of US Fed meet, experts gaze into their rate-hike crystal balls: Here's what they foretell

Investors and markets across the world will keep a close eye on what transpires at the US Federal Open Market Committee (FOMC) meeting that starts late tonight Indian standard time.

The two-day (March 15-16) meeting will be an important turning point in a global interest rate regime that kept rates low and markets awash in liquidity over the past two years of the COVID-19 pandemic.

The meeting assumes importance not only because it will determine the magnitude of the first rate hike by the Fed in three years as it battles inflation in the world’s largest economy that is at a multi-decadal high; experts will also be reading the fine print minutely to gauge the course of action the US central bank will adopt without jeopardizing economic recovery.

The big question confronting the Federal Reserve is how to rein in inflation and limit fallout on the US economy and equity markets that have been rocked by geopolitical tensions that climaxed in Russia’s invasion of Ukraine starting on February 24. The invasion, which prompted sanctions on Russia by the United States and its allies, threatens to disrupt the global supply chain including soft commodities like wheat and corn as well as minerals and metals.

“Globally, economies have barely begun post-pandemic recovery and have to face the challenge of the inflation bogey,” said Sunny Agrawal, deputy vice president of SBI Securities.

Street expectations

With inflation in the US spiking to  7.9% in February 2022, the highest since January 1982, the Fed has no choice but to act. The Street consensus is for a 25 basis point hike in the meeting. One basis point is one-hundredth of a percentage point.

“However, there is a small probability of a more aggressive hike of 50 bp given the inflationary pressure,” suggested Gaurav Dua, head of capital market strategy at Sharekhan by BNP Paribas.

The fact that inflation is at a 40-year high and that core PCE (personal consumption expenditure) inflation is at a 30-year high makes it imperative for the Fed to steadily tighten monetary conditions.

“With unemployment at 3.8 percent, the labour market is already tight, so it was a policy error to add more securities to the Fed’s balance sheet in December-February (the last 3 months), even if the increases were occurring at a slower pace than in previous months”, said Prasenjit K Basu, chief economist at ICICI Securities. 

Projected rate hikes 

“We expect the Fed to be obliged to raise the Fed Funds rate at every one of its remaining meetings this year, taking the target Fed Funds rate to 1.75 percent by the end of 2022 – implying there will be at least one hike of 37.5 bps to normalize the rate,” added Basu.

Some experts said the Fed could raise rates four to seven times in the next year depending on the evolving situation.

“Markets anticipate a 25 basis point rise at this meeting, but pricing has risen to indicate a 70% chance of a larger 50 basis point hike at its subsequent meeting in May, due to concerns about inflation,” said Deepak Jasani, head of retail research at HDFC Securities. “The US Fed has never raised interest rates when the yield curve is this flat and volatility so high”.

The global finance community will also be closely watching the Fed’s commentary for clues related to bond purchases and how it intends to unwind its heavy balance sheet.

“Markets will look for any indication/timelines by FOMC to pare its existing bond holdings after asset purchases end by this month's end,” said Nishit Master, portfolio manager at Axis Securities.

Impact on global markets

The Street will look for clues to the Federal Reserve’s roadmap for rate hikes and how supportive the central bank is of growth.

“We believe equity markets have already discounted a rate hike to the tune of 25 -50 bps for the upcoming Fed meeting,” said Agrawal of SBI Securities.

Jasani of HDFC Securities believes that if the rate hikes are faster and sooner than expected or there are any indications of them being so in the Fed’s commentary, the global markets could react negatively.

Also, a rate hike will strengthen US 10-year bond yields which will be a negative for bond portfolios globally.

“By the end of CY22, one can expect US 10-year bond yields to inch up toward 2.75 to 3.00 percent and we may see globally money shifting out of bond portfolios and moving towards equity,” added Agrawal.

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