FED Hints at Rate Hikes from March 2022

Fed Hints at Rate Hikes from March 2022

Indian Market
by 5paisa Research Team Last Updated: 2022-08-08T19:00:57+05:30

The FED statement by Jerome Powell maintained status quo on rates in its 26-January FED meet. But that was hardly the focus. Markets were looking at guidance and the guidance came out crisp and clear from the US FED. The first rate hikes will happen as early as March 2022.

The reasons are not far to seek. In last 22 months, inflation has shot up to 7%, growth is back to above pre-COVID levels and the labour situation is near full-employment. The signals of a rate hike have been there all around. The US 10-year bond yields are up 40 bps since the Dec-21 FED meet touching 1.85% levels. Dollar Index (DXY) is up from 92 to 97 since Sep-21. But first let us look at how the bond buying program will wind down to zero.

Bond buying to level zero by Mar-22

Rates are one side of the FED story; the other side is liquidity. That is reflected by the Bond Buying. Now FED has clarified that fresh buying of bonds will be down to ground Zero by mid-March 2022. Here is the time table.
 

Details

Oct-21

Nov-21

Dec-21

Jan-22

Feb-22

Mar-22

Bond Buying

$120 billion

$105 billion

$90 billion

$60 billion

$30 billion

-Nil-

 

Remember, this is the fresh buying. There is the larger issue of unwinding the $9 trillion bond portfolio that the FED is holding. For the first time, there is a commitment from the FED that the bond $9 trillion bond portfolio could unwind at the rate of $100 billion of liquidity sucked out each month. It is not yet clear when this will start, but if growth is intact after the first rate hike, then bond portfolio unwinding may start soon enough.


Here is what Jerome Powell in the FED Statement


The FED statement by Jerome Powell left no one in doubt about the FED’s hawkish intentions. Here is the gist of what the FED plans to do in the coming months.

a) FED rates will rise in March 2022, and actual rate hike could be 25 bps or 50 bps, based on the macro situation. Jerome Powell has expressed confidence in the ability of the US economy to withstand a good dose of hawkishness.

b) In terms of guidance, we can rely on the CME Fedwatch. Here is what it indicates. There could be rate hikes of 75 bps to 100 bps by June 2022. By December 2022, the rates are expected to be up by 150-175 bps. The rate hikes to normalized levels of 2.25% would be completed by June 2023; hinting at a lot of front ending.

c) One of the reasons for the FED hawkishness and Powell’s aggressive language was the confidence in growth sustaining. Powell has hinted there is enough room to raise interest rates without threatening labour market or GDP growth in next 3 years.

d) The biggest trigger was the retail inflation at 7%; the highest level since 1982. Also, this is the longest that FED has waited to hike rates after a sharp spike in inflation.  FED has dropped the word “Transitory” to describe inflation. It looks, inflation is here to stay.

e) FED was non-committal on balance sheet downsizing but FOMC has released a paper outlining “principles for reducing the size of the balance sheet”. What one can logically infer is that the FED is preparing to significantly reduce bond holdings.

Check - Highlights of the Jerome Powell FED Testimony

News is not great for India, but focus shifts to Union Budget

If the market reaction across Asia and India to the FED statement is any indication, then the sentiments have been certainly against equities. The markets are expecting global investors to shift to safer havens. As we write, the Sensex has lost over 1,300 points on Thursday and has given up more than 5,000 points in the last one 7 trading sessions.

Indian markets are up against two key challenges. To begin with, higher rates will impel the RBI to raise rates to narrow the yield gap with US bonds. Secondly, balance sheet contraction would mean that passive liquidity of ETFs may be down drastically.

This also means that the onus shifts to the Union Budget. The Finance Minister must take this opportunity to provide an India-centric budget that leverages on a sustainable Indian recovery. India has relied on the direction of global flows for tad too long.

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