NO SURPRISES HERE – A 0.25% RATE HIKE BY FOMC

By Ruma Dubey

The Federal Reserve did not disappoint. It did the expected – hiked rates. And the rate hike was also on expected lines – 0.25%.

This was news which was already discounted for in many ways. What one was looking for was cues for number of rates hikes to come forth in 2017. And also what the Fed was going to do about the balance sheet shrinking process.

That news came in too. As against the widely expected 2-3 hikes this year, there is only one more rate hike planned for 2017. There was word on balance sheet reduction too. The Fed said that it would stop the balance sheet shrinking process if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Interpretation of this statement – interest rate changes , like always will remain dependent on the data – if the economy slumps or falters again, the Fed could change its interest rate stance along with the economic ups and downs but when it comes to shrinking its balance sheet, it will trudge on ahead, irrespective of the data coming in. So shrinkage of balance sheet and rate hikes are not connected.

In the ensuing quarterly Press Conference, Janet Yellen spelled out details on the path to be taken to shrink its $4.5 trillion balance sheet. She said that the trimming of the balance sheet will begin this year while the process of shrinkage could take a “few years,” without actually spelling out how far it will shrink the balance sheet. Yellen only indicated that it will be "appreciably" smaller than its current size of $4.5 trillion, but likely to be much larger than before the financial crisis. Wonder what level Yellen is really looking at?  There was no word on the exact timing of when the process will begin this year, as well as specifically how large the portfolio might be when finished.

Yellen, whose term ends in February 2018 was asked about her future plans; whether she could be reappointed second term as Fed Chairwoman. She said that she plans to complete her term and had no conversations with the President about future plans.

A quick look at the highlights of the FOMC statement:

• The Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent – this means one more rate hike in 2017.
• The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.
• Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term.
• Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.
• 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.
• Balance sheet to shrink by gradually rolling off a fixed amount of assets on a monthly basis - initial cap will be set at $10 billion a month: $6 billion from Treasuries and $4 billion from mortgage-backed securities (MBS).  The caps will increase every three months by $6 billion for Treasuries and $4 billion for MBS until they reach $30 billion and $20 billion, respectively.

How will all this affect the Indian market? A 25 bps rate hike was expected and as said earlier, almost discounted for. There is no major flight of funds expected from FIIs; after all today India is amongst the top rated place to park funds. Given that fact, maybe some FIIs might pull out funds but that too is expected to be short term. FIIs were net sellers and DIIs were net buyers in the market yesterday; we might see the same trend continuing today too. The rupee needs to be watched; it has been steady and more gaining than losing against the dollar but today, rupee could see some depreciation as has always been the trend after a rate hike.

So the Indian equity markets will continue to remain more or less range bound as currently, there are simply no major triggers ahead. The ongoing NPA resolution will continue to hog the limelight till end of June when the nation gets ready for GST, starting 1^st July. Now that is going to be disruptive and the market will brace itself for that eventuality ahead. Monsoon will bring in cheer but because it is no longer a worry, it won’t be a reason to celebrate also.