FED HIKES RATES BY 0.25%; TWO MORE HIKES PENCILED IN FOR 2017

By Ruma Dubey

This was very much on the expected lines. No one can say that this came out of the blue – a 0.25% rate hike was a given, rising it to a range between 0.75% and 1 %. That’s exactly what Janet Yellen did. More importantly, the Fed see’s two more rate hikes in 2017.

The Fed expects three more 0.25% hikes in 2018 and by December 2019, the Fed see’s the long-run settling at average of 3%.

The other highlight – The Fed did not change its view even a wee bit about the US economy; it remains where the Fed saw it three months ago.

What all this means is that the Fed remains confident that the US economy will progress as expected  and that’s a good thing for rest of the world.

A quick look at the highlights of the Fed statement:

• The Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent.
• The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.
• The actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
• Core inflation to move up to 2% over the next couple of years
• Yellen says, “Waiting too long to scale back some accommodation could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession.”
• Fed officials see the economy growing 2.1% in 2017, the same pace as in December.
• Fed estimates growth at 2.1% in 2018 and 1.9% in 2019 before settling at its longer-run average of 1.8%.
• Unemployment rate is expected at 4.5% by the end of the next three years. Projections for the longer-run unemployment rate ticked down to 4.7% from 4.8% in December.

This is also an event now behind us and the market will react accordingly. FIIs knew all along that the fed rate hike was coming in this month yet data shows that in March, from 1^st till 14^th March, they remained gross buyers to the tune of Rs.13,248 crore. They were sellers month after month from October to January but since then, FIIs have been net buyers.

But there is a catch here – the Fed has talked about two more rate hikes this year. This somewhat skews the carry trade math – the US investors borrow from the US due to their lower interest rates and invest in Indian markets, thus bringing down their risk-adjusted gains. But when more rate hikes are round the corner, it means India becomes less attractive for the carry trade and we will see some of the most risk-averse money amongst carry-traders going back into the US. There will be some who will now sell their Indian investments and take money back into USA – they will convert rupees from their sales to US dollars, which in turn means that the demand for dollars will rise will rupee demand will go down, leading to depreciation of rupee vis-à-vis the US dollar.

The rupee has been strong last two days, getting to a 16-month high yesterday but we could see a reversal as a knee-jerk reaction to this rate hike.

As we say always, India story remains intact and that is a fundamentally good reason to stay invested. RBI reducing rates when inflation is showing signs of ticking up seems improbable as of now.