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Global stock markets have been in a volatile phase with a negative bias for quite some time now, given the unfavourable economic and non-economic factors. The Russia–Ukraine crisis doesn’t seem like abating soon which is resulting in elevated fuel, food and commodity prices. The markets which gained some comfort with the opening up of the Chinese economy was in for some more shock with the outbreak of a fresh Covid wave in Beijing.
A rising inflation world wide has become the bone of contention for the central banks and economists across geographies. All emphasis is now being laid to control inflation for which the central banks have become more hawkish in their approach, and efforts to stem economic growth have gone somewhat on a backfoot.
The Federal Reserve in its last meeting had decided to raise rates and maintained its hawkish stance. US Fed Chairman Jerome Powell had signalled that the Fed’s policymaking committee expected to implement 0.5 percent increases at its next two meetings, but was not “actively considering” a more aggressive 0.75 percent increase.
The annual pace of consumer price inflation in the US hit 8.6 percent in May as energy and food costs surged. US Treasuries have jumped since the start of April and is above the 3 percent mark.
“Most expect that Fed rates could reach up to 3 percent by next February,” said a report from Motilal Oswal Financial Services. “In the recent times, treasuries have been under pressure as the Fed began its long-drawn process of quantitative tightening, reducing its balance sheet by allowing bonds that it bought to mature without replacing them.”
The latest consumer price inflation in the US reached a 40-year high, causing a major concern for the Federal Reserve. “The equity markets are falling over concerns of soaring prices which mounted further following the release of the numbers and on anticipation of more hawkish stance by the Fed which is now expected to increase the interest rates by at least half-percentage point in a bid to tame inflation,” said Ravi Singh, Vice-President and Head of Research at ShareIndia.
Experts, however, believe that if the Fed acts more aggressively, then the fear of plunging the economy into recession may trigger more sell-off in the market.
“Traders see a 100 percent chance of a 75-bps rate hike in June, a 91 percent chance of a 75 bps rate hike in July, and a 50-bps rate hike fully discounted from each of the September and November meetings,” said Deepak Jasani, Head of Retail Research at HDFC Securities. The main Fed rate is expected to rise to 3.68 percent by the end of 2022.
“The recent inflation print of 8.6 percent for May reignited bets of steeper rate hike trajectory and we believe a 75-bps hike is priced into the market expectations and hence may not lead to any sharp reaction in the markets,” said Garima Kapoor, Economist at Elara Capital. “More than the current rate hike, the guidance as well as the language during the press meet will be more crucial,” she added.
The markets have braced for a hawkish Fed, but investors will look for signal that the central bank is willing to get even tougher with rate hikes.
“We can expect a rate hike of 0.75 bps, given the inflation numbers which have come out and any hike above 0.75 bps will be negative and one could see more correction coming in,” Juzer Gabajiwala, Director of Ventura Securities Ltd, said. The coming cycles will be again dependent on the inflation data and how it pans out.
However, Sonam Srivastava, Founder of Wright Research, thinks that the market has already priced in a higher rate hike this time after the inflation numbers came out, but sees the volatility to persist even after this hike.
“We believe that there will be 50 bps further rate hike in the September and November meetings as well apart from the expectations of 75 bps hikes in June and July, which would take the fund rate to 3.25 percent,” said Mohit Nigam, Head of PMS at Hem Securities. “We believe that the markets have not waited for the Fed meeting and they have already been front running them with digesting the quantum of rate hike,” he said.
“The Fed is under pressure to quickly take its policy rate to the neutral level that neither stimulates nor restricts - and beyond,” said a report from Motilal Oswal.
In its last projection report, the Fed expected that growth in the US could be at 2.6 percent and 2 percent for 2022 and 2023. On the other hand, jobless rate was predicted to average at the current level of 3.6 percent this year and the next, before mildly picking up to 3.8 percent in 2024.
“Given upside inflation risk and very tight labour markets, monetary policy makers are likely to move policy to a tight stance, where rates stay above 'neutral' to better balance the shift back to an upside inflation risk profile,” the Motilal Oswal report said.
“The commentary on winding down of Fed Balance sheet through Quantitative Tightening (QT) will be in focus and expect the equity markets to be volatile in the short term on account of rate increases, Rupee depreciation and liquidity tightening through QT,” Nishit Master, Portfolio Manager at Axis Securities, said.
Once the rate expectations stabilise and markets get used to the liquidity tightening, he expects the equity markets to also stabilize. One should use the current short term volatility to build good quality long-term portfolio.
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