Even as the May consumer price and retail sales reports will be released on Wednesday morning during the Fed’s two-day deliberations, it is unlikely to change the outcome for a rate hike in June
5Paisa.com (an IIFL Subsidiary)
The US Federal Open Market Committee’s (FOMC) two-day rate-setting meeting is in session since Tuesday and most Fed watchers believe Governor Janet Yellen is poised to raise interest rates tonight, a third time in seven months.
One of the most accurate indicators, the Fed Watch tool on Chicago Mercantile Exchange indicates about 96 percent of traders expect a rate hike.
While some have indicated sluggish US economic growth as a possible deterrent to the rate hike, Fed officials have clarified that they are not worried about the strength of the economy.
They view weak first quarter growth as transitory and believe inflation will resume rising toward the central bank’s 2 percent target.
Even as the May consumer price and retail sales reports will be released on Wednesday morning during the Fed’s two-day deliberations, it is unlikely to change the outcome for a rate hike in June; however, softer than expected data could put the September hike at risk.
While almost everyone is in agreement with a rate hike decision on Wednesday, most Fed observers are divided about what Janet Yellen would say this week about Fed’s plans to shrink its $4.5 trillion balance sheet.
The big question is whether the central bank will start the roll-off in September or December, assuming the economy stays on course.
The Fed rate hike will have ramifications for the global markets and especially the emerging markets. Let us understand how India’s markets and economy are likely to be impacted at this juncture.
The usual scenario after a Fed rate hike has been that of sharp fall in equity indices, a weaker rupee and sustained foreign fund outflows.
However, this time the impact may not be as sharp considering India’s economic strength in the emerging market space and lack of better investment destinations besides India.
The portfolio investors may not fly away from India for a long time after the Fed rate hike as not many would want to miss out on the enormous growth opportunity ahead. However, we should consider the following short-term impacts on the Indian economy and markets.
The Fed rate hike is likely to lead to Rupee depreciation, due to the cascading effect on all emerging markets. Not much of intervention is expected from the Reserve Bank of India (RBI) as the focus of RBI now is more towards domestic parameters such as inflation and growth.
If RBI further reduces domestic interest rates, it will further add to the Rupee fall, as the subsequent interest rate hikes by US Fed will reduce the gap between interest rate differential between US and India.
The sustained rate hardening approach of Fed might result in some foreign fund outflows from India in the short-term. Improved US bond yields may result in some outflows or limit future portfolio investments to some degree by investors as they might prefer to invest in US market both in debt (better yield) and equity (better economic growth).
The rate hike will bring volatility in the bond markets as it will drive down the price of the 10-year domestic bond.
Equity Market Downside
The stock markets in the short-term would also be impacted by the rate hike due to the outflow of Foreign Funds. However, due to the fundamental stronghold, India would be better off compared to other emerging markets.
The consequent rate hikes would most likely affect the earnings of companies with foreign revenue or debt exposure. Earnings of Import oriented companies will be under pressure with a weaker Rupee, whereas export-oriented industries will benefit from favourable foreign exchange gains.
Long-term Impact Unlikely
Considering the strong growth in India, it is unlikely that the long-term investment story of India will get impacted due to the rate hike.
But, in the short run, the negative effects of FII outflows in expectation of the Feds move will outweigh the positives of a stronger macroeconomic picture, improving fundamentals and any significant influx of capital from DIIs.Disclaimer: The author is CEO, 5Paisa.com (an IIFL Subsidiary). The views and investment tips expressed by investment experts on Moneycontrol are their own and not that of the website or its management.The Great Diwali Discount!
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