As flows exit EM, a recap of US Fed's comments on rate hike

The gyrations in fund flow into emerging markets may continue for some more time. EPFR Global told CNBC-TV18 this morning that big fund flow movements into India may not return very soon, given the direction of interest rate trendline in the US, and concerns over crude oil. This is fanning volatility in the US markets too. The measure of volatility - CBoE VIX - has already hit its highest level since November 2020.

The US central bank has already signaled a series of rate hikes for 2022 and the two-day meeting is expected to offer clarity on the Fed’s course, especially on tapering the monetary stimulus it has offered to shore up the COVID-hit economy.

According to ING Group, the Federal Reserve is expected leave interest rates unchanged this time but it anticipates an immediate end to quantitative easing (QE) asset purchases.

The US Fed decision is likely to set the course for Indian equities. A hike in interest rates in the US has an impact on the debt and equity markets, not just in the US but also in emerging economies such as India that have witnessed record foreign portfolio investments (FPI) over the last year. Unabated foreign fund outflows also put pressure on domestic equities.

With the economy regaining all of its lost output, inflation running at its highest rate since 1982 and the unemployment rate dropping below 4 percent, there is plenty to justify policy normalisation, ING Group said in a note.

Financial markets are now fully pricing a March rate hike with a further three moves expected during the course of 2022.

“We see no reason for the Fed to continue purchasing assets and expect them to announce an immediate conclusion to their QE asset purchase program. This earlier corrective action on the balance sheet would also help reduce talk of a potential 50bp March rate hike, while opening up the possibility of an earlier start to a shrinking of the balance sheet,” the note added.

Higher interest rates will help controlling the inflation by slowing down the flow of money, which has been circulating in the economy following the $10 trillion worth of stimulus.

Here’s a recap of US Fed Chairman Jerome Powell’s recent comments on inflation and rate hike:

Normalisation

“As we move through this year … if things develop as expected, we’ll be normalising policy, meaning we’re going to end our asset purchases in March, meaning we’ll be raising rates over the course of the year… At some point perhaps later this year we will start to allow the balance sheet to run off, and that’s just the road to normalising policy.”

Tighter policy

The US economy is healthy and in need of tighter monetary policy. He expects a series of interest rate hikes this year, along with other reductions in the extraordinary help the Fed has been providing during the COVID-19 pandemic.

No need for an accommodative stance

The moves are in response to an economy that has both a strong jobs picture, with an unemployment rate at 3.9 percent in December, but with inflation expected to top 7 percent year over year for the same period.

“What that’s really telling us is that the economy no longer needs or wants the very highly accommodative policies that we’ve had in place to deal with the pandemic and its aftermath,” Powell said.

“We’re really just going to be moving over the course of this year to a policy that is closer to normal. But it’s a long road to normal from where we are.”