The US Federal Reserve on Wednesday raised its benchmark Fed Funds Rate by an expected 50 basis points to a range of 4.25-4.50 per cent, the highest in 15 years. This was the seventh interest rate hike by the Fed this year as it battles a sharp rise in inflation over the last 12-15 months.
Recent US inflation data shows its softening. Consumer prices rose 7.1 per cent over 12 months ending November, compared with 7.7 per cent in October. However, it is still close to a 40-year high and way ahead of the central bank’s 2 per cent target.
Contrary to hopes that the Fed would slow down the quantum of rate hikes further and perhaps start cutting rates towards the end of 2023 as inflation had begun to soften, Fed chairman Jerome Powell sounded far more hawkish, warning there will be more interest rate hikes and they are likely to remain higher for longer, even as there are risks that high-interest rates would push US economy into a recession.
“Reducing inflation is likely to require a sustained period of below-trend growth and some softening of labour conditions,” Powell was quoted by Reuters as saying in the post-FOMC meeting press conference.
The Fed funds rate, most FOMC members now expect, could be well above 5 per cent in 2023, which is more hawkish than expected, said Neelkanth Mishra, co-head of Asia Pacific Strategy and head of India Securities Research at Credit Suisse.
“The Fed, for very right reasons, is worried about entrenched wage pressures, while goods inflation is coming off. From an overall rate perspective, the nuance we need to focus on is not just what the peak rate is, but how long rates stay high. There is also quantitative tightening happening, over and above the higher rates,” pointed Mishra.
A tighter dollar market and reduced appetite for dollar loans could be bad for growth and weigh on equities.
“We need to be a bit apprehensive till the time Fed is convinced they have broken the back of inflation and things can start easing,” added Mishra.
Notwithstanding some initial signs of a weakening economy, the Fed continues to worry about a strong labour market, feels Hemang Jani, head of equity strategy at Motilal Oswal Financial Services.
“Interestingly, although the growth projection was revised down (to 0.5 per cent from 1.2 per cent) for 2023, the unemployment rate revisions were only marginal (4.6 per cent to 4.4 per cent). Overall, we are more convinced that while a Fed pause could come by mid-2023, a cut is unlikely before 2024 now,” he said.
In a world that has become increasingly interlinked in recent years, the moves by the Fed would have ramifications in other economies, including India.
The Dollar has already strengthened this year and as interest rates in the US have risen, foreign institutional investors have been huge sellers in equities in emerging markets, including India. The trend seems to be reversing, they bought shares worth Rs 36,239 crore in November and Rs 8,685 crore, so far in December. Still, for the calendar year 2022, foreign portfolio investors have been net sellers to the tune of Rs 1.24 lakh crore.
That would typically weigh on stock prices. Yet, the benchmark BSE Sensex, for instance, has risen a little over 8 per cent in the past 12 months, outperforming many other markets. Strong domestic retail flows into mutual funds via systematic investment plans, coupled with inflows from EPFO (Employee Provident Fund Organisation) and insurance companies are countering FPI outflows.
According to Credit Suisse, rolling 12-month DII (domestic institutional investors) flows are at a record high of $40bn. It expects DII flows into equities to sustain, with insurance likely to pump in around $12 billion, $7-8 billion expected from EPFO and around $18-20 billion coming in through SIPs in MFs.
Healthy bank balance sheets and corporate earnings is also aiding Indian markets.
So, while there could be near-term pressure on markets (the Sensex was down around 500 points in afternoon trade on Thursday), a deeper correction is unlikely say, analysts.
“We don’t see a case for deep correction in our markets given the drop in crude and commodity prices and likely margin expansion for many sectors like cement, consumer, auto and specialty chemicals,” said Jani.
Credit Suisse expects India’s economic growth to beat expectations in 2023 and sees GDP growth to be stronger than the current consensus forecast of 6 per cent in 2023-24.
“We are expecting a stronger acceleration in India’s GDP growth in 2023 owing to several domestic growth drivers. Revival in government spending, increase in low-income jobs and easing of supply-chain bottlenecks should partly offset the impact of rate hikes, a slowing global economy and the need to reduce the balance of payments deficit,” said Mishra of Credit Suisse.
Credit Suisse’s Global Equities Strategy team has upgraded India from ‘Underweight’ to ‘Benchmark’ for 2023, although it stopped short of going ‘overweight’ due to concerns over high valuations and a weakening balance of payments situation.
Global growth is seen slowing in 2023, which is likely to push energy prices lower. That would in turn reduce the pressure on India’s oil import bill next year. But, slowing exports and weaker capital inflows are now risks to India’s balance of payments deficit, added Credit Suisse.