On Wednesday, the US Federal Reserve decided to hold interest rates, but signalled that a rate hike in December was not out of the question.
In fact, Fed chair Janet Yellen said a rate hike would be required to prevent the economy from overheating.
The Fed’s decision not to hike interest rates has been met with some cheer by the Indian markets with the benchmark Sensex rising 1% in early morning trade on Thursday.
Here’s all that you want to know about why the Fed held rates this time and what a future hike might mean for India.
Why did the Fed decide to hold rates? Was this decision expected?
Fed chief Janet Yellen said that, although the prospects of US growth had brightened, it decided to wait before hiking rates. “We judged that the case for an increase has strengthened but decided for the time being to wait,” Yellen said, adding that “the economy has a little more room to run”.
Yes, the Fed’s decision was widely expected by economists and markets. Moreover, this decision came just a day after the Bank of Japan announced a complete overhaul of its own policy framework.
Does this mean a rate hike later this year is imminent?
Yes. In fact, Yellen hinted as much. Reuters cited her as saying that she expected one rate increase this year if the job market continued to improve and major new risks did not arise.
Having said that, there’s nothing cast in stone. Last December, the Fed had signalled four rate increases during 2016, but that did not happen.
What are the key takeaways from the Fed’s decision, especially for India?
The Fed expects the US economy to grow 2% next year and the year after that, although the projection for the current year is a tad lower at 1.8%. Moreover, rates hikes in 2017 could be gradual. “We continue to expect that the evolution of the economy will warrant only gradual increases in federal funds rate over time to achieve and maintain our objectives,” Yellen said.
What does the Fed’s stance mean for India?
For now, this is good news for India. This basically means that the Indian and other emerging markets could see some buoyancy for a while, rather than being range-bound.
A rate hike in the future could prompt foreign institutional investors to take out some money out of India. But that will also depend on whether the Reserve Bank of India (RBI) lowers interest rates next month. Raghuram Rajan, whose term as the RBI chief ended early this month, had steadfastly refused to lower rates during the last few monetary reviews. The new chief, Urjit Patel, is under a lot of pressure to do that.
How have Indian markets reacted to past US Fed rate hikes?
Citing a recent Citigroup report, Business Standard says that the Indian market’s reaction to past Fed rate hikes has been mixed, with market returns being positive in most cases when the US rate hike cycle began.
While Indian markets fell sharply on the day of the Fed rate hike in February 1994, June 1999 and June 2004, they were actually positive in March 1997 and December last year. Also, in the year following the hikes, markets have tended to surge sharply, with the Indian markets actually growing by more than 50% following the Fed rate hike in June 2004.
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