EspressoLogy

The US Federal Reserve rate hike and its impact on the Indian market

The term federal funds rate refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. 

The FOMC has been hiking the federal interest rate continuously for quite some time now, the latest blow came in July-22 when interest rates were raised by 75 basis points for the second straight month, with the committee accepting the possibility of raising it further going ahead.

Measures like rate hikes by the Federal Reserve not only impact the US economy but also shape global macroeconomic outlook, exerting a certain degree of influence on monetary policies in other emerging economies like India.

Following are the fronts on which the Indian economy stands to be affected:

1. Foreign investors cashing out: 

Emerging economies like India typically experience higher inflation and interest rates than developed nations like the US. Financial institutions, especially foreign institutional investors (FIIs), seek to borrow money from the US at low-interest rates and then invest that money in government bonds of developing nations like India to earn higher interest rate. With higher interest rates available in the USA, investors move their money to dollar denominated bonds, thus sucking the liquidity out of all emerging markets in one shot

2. Imported Inflation:

India is a net import country (imports > exports) which means that rising prices world over have a direct impact on the prices of everything domestically. With crude oil at record highs and rising demand for the US dollar, WPI inflation in India rose to 15.18% in the month of June-22

3.Impact on households:

A potential domino effect of rate hikes is policy tightening on a domestic level. The RBI announced a further 0.50 bps rate hike in August-22, raising the benchmark rate to 5.4%, the highest since 2019. This will directly impact domestic households, with your EMIs set to increase for everything from car loans to home loans. 

4.Uncertainty of impending recession: 

Following rapid rate hikes, the US is at a higher risk of a recession. This is evidenced by the inverting of the yield curve, with short term interest rates being higher than long term ones. Its effects on the Indian markets, are anyone’s guess at the moment, but the uncertainty prevails.

5.Dampening of demand and corporate profits:

The rise in US interest rates and the tightening of global liquidity in the form of quantitative tightening will cause demand to be muted, which should result in slower corporate growth and profitability. Additionally, investing money in markets will have a higher opportunity cost. Poorer stock markets are typically caused by slower growth prospects, lower profitability, and higher discounting rates.

Resilient Indian equity markets

It is worth noting that India has been a sigh of relief amidst the chaos. The 75bps rate hike was priced in by the markets and the mood has slowly been changing from mid-July, with the benchmark indices up 10-12% in early August from their lows in mid-June. This is also reflected in FIIs becoming net buyers of equities in July-22, their first time in 9 months.

Therefore, we learn that the positions of the economies in the US and India are significantly different. The Federal Reserve has been relatively behind the curve and is now attempting to catch up and control inflation that poses a systemic threat. Since the RBI in India has maintained its lead, policy rates here aren't rising as quickly as they are in the US. With domestic conditions now neutral, the effect on the Indian equity markets will only be a spillover from the US markets. The Indian economy is prepared for a long period of prosperity and acting on such transient impulses may rob investors of the long term gains that are predicted to accrue.

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Please refer the Risk Disclosure Document issued by SEBI and go through the Rights and Obligations and Do’s and Dont’s issued by Stock Exchanges and Depositories before trading on the Stock Exchanges. Brokerage will not exceed the Exchange prescribed limit.