Anubhav Sahu Moneycontrol Research
At a speech on November 28, Federal Reserve Chairman Jerome Powell made crucial implications for the Fed policy rate and the way forward on US interest rates and hence global capital flows.
Powell asserted that policy rate is below the neutral rate, or the rate at which it neither stimulates nor restrains economic growth by changing its interest rate policy. This is in contrast to Fed’s September meet statement and follow-up speeches, and therefore opens up possibilities of Fed going slow on rate hikes, particularly in 2019.
He also qualified that policy actions have a lagged effect of more than a year and therefore anticipating future stages is crucial.
Dial back – September Fed meet
At its September 26 policy meet, the Federal Reserve took a hawkish stance, which led to a sharp steepening in the treasury yield curve. The dot plot (see chart below) suggested higher conviction for a December rate hike and three rate hikes in 2019.
In his speeches after the Federal Open Markets Committee, Powell emphasised that Fed was long way from the neutral rate and also hinted that in the short term the Fed Fund rate might exceed the neutral rate. This implied steeper trajectory for a rate hikes.
FOMC participants Fed rate projections as per September meet
Source: Federal Reserve
Implied market probability for rate hikes are lower
While market continues to expect a higher possibility (about 80 percent probability) of a rate hike at its December meet, that’s not the same for 2019. For instance, there is an around 50 percent expectation of a rate hike at its March meeting. Overall, the implied rate hikes for 2019 is 1.4, which means that the consensus expectation is near one rate hike only.
Nifty performance and US 10-year yield
Source: investing.com, moneycontrol.com
Financial stability vulnerabilities moderate
On financial stability, Powell underlined that conditions with respect to the banking system and the strength of the consumer balance sheet are sound. However, he cautioned on elevated corporate debt. For the stock market, he emphasised that current valuations are broadly in line with the long term levels and do not see 'dangerous excesses' in equities.
Implications
Hawkish context provided by the Fed at its September meet, intensified trade war and elevated oil price had weighed on emerging market asset classes. In the recent past, few of these factors have come to the state of reckoning. Oil prices have tumbled recently and the possibility of a production cut would be watched at next week's OPEC meet (December 6). Similarly, US President Donald Trump and Chinese President XI Jinping will meet in the backdrop of the G-20 summit (November 30–December 1) would be closely followed.
An apparent change in stance by the Fed can have similarly far reaching implications for emerging market assets. The dollar-rupee currently below 70 and this was the level last seen in August.
A moderate rate path by the Fed could ease off pressure on EM currencies and have a positive implications for EM in terms of fund flows, commodity imports and inflation. Hence, the Fed meet on December 18-19 would be crucial in understanding further if there is a course correction.
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