Impact of US Feds' biggest rate hike since 1994 on India
- Fed's interest rate on loans to banks to jump to 3.4% by the end of the year
- Fed's key interest rate will be raised by three-quarters of a percentage point to a range of 1.5% to 1.75%
- In India, major indices opened higher on Thursday
The Fed raised interest rates for the third time since March, following an unexpected increase in US inflation last month. The US Federal Reserve has signalled similar-sized rises later this year, possibly undermining the already shaky investor sentiment across markets.
Following the completion of a two-day Federal Open Market Committee (FOMC) meeting on Wednesday, central bank head Jerome Powell hinted that the Fed's key interest rate will be raised by three-quarters of a percentage point to a range of 1.5% to 1.75%.
Forecasts issued following the meeting showed officials expecting the Fed's interest rate on loans to banks to jump to 3.4% by the end of the year.
Investors across the world have been looking for hints that the Fed will be more aggressive in winding down the stimulus that has been fueling stock market gains throughout the globe.
The revised forecasts are viewed as a decisive step to accelerate the turnaround of the central bank's expansionary monetary policy implemented in early 2020 to restrengthen the American economy in the aftermath of the Covid-19 pandemic.
Part of this assistance came in the shape of an extraordinary bond-buying programme meant to reduce long-term interest rates and stimulate more borrowing and spending by both consumers and businesses.
After an early decline, the Dow Jones Industrial Average surged sharply during Powell's post-meeting press conference, before paring gains and concluding the trade on Wednesday.
In India, major indices opened higher on Thursday, June 16, mostly because markets had anticipated the rate hike following the release of May US inflation data last week.
The recent boost is also considered a recognition of the Fed's determination to combat inflation, after being seen as falling behind the curve in managing prices.
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The US Fed, like other central banks, uses policy instruments to regulate the supply and cost of credit in the economy to drive employment and inflation.
The federal funds rate is the Fed's key monetary policy instrument, and changes it, drives other interest rates, which in turn impact borrowing costs for households and businesses.
Furthermore, the bond-buying programme, also known as quantitative easing, was implemented in 2020 as an exceptional step to assist financial markets and the economy in limiting the impact of the pandemic.
The Federal Reserve isn't the only one that wants to raise interest rates. The Bank of England is likely to announce its fifth rate hike since December on Thursday, June 16, sending its key rate above 1% for the first time since 2009.
Borrowing becomes more expensive as interest rates rise in an economy, so people are less likely to buy products and services, and businesses are less likely to borrow funds to grow, acquire equipment, or invest in new ventures.
The following drop in demand for products and services lowers salaries and other prices, putting surging inflation under control.
According to some analysts, a signal to raise policy rates in the United States ought to be negative for developing economies, particularly from the standpoint of the debt market.
In developing markets such as India, inflation is higher and so interest rates are higher than in developed countries. As a result, investors, particularly Foreign Portfolio Investors, choose to borrow in the US at lower interest rates in dollar terms and invest that money in bonds in nations such as India in rupee terms to earn a greater rate of return.
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When the Fed hikes its key rate, the gap between the two nations' interest rates narrows, making countries like India less appealing for currency carry trade.
A Fed rate hike would also mean less momentum for growth in the US, which might be disappointing news for the global economy, especially because China is still reeling from the effects of the real estate crisis.
High yields in US debt markets may cause a churn in developing market shares, dampening foreign investor confidence.