In the June meeting of the Federal Open Market Committee (FOMC), the US Fed hiked the rates by 25 basis points. This marks the fourth rate hike by the Fed since it first hiked rates in December 2015 after a gap of almost 9 years. The Fed has since effected rate hikes of 25 basis points each in December 2016, March 2017 and now in June 2017. Effectively, the Fed rate has gone up from a low of 0-25 basis points range to the range of 100-125 basis points.  What has the Fed guided on the rates front going ahead?

Just one more rate hike in 2017..
The Fed in its latest policy announcement has virtually affirmed that there will just be one more rate hike this calendar year. That will be in sync with the original estimate of 3 rate hikes by the Fed during the calendar year 2017. Additionally, the Fed has guided that there will be additional 3 rate hikes in the calendar year 2018, which could take the upper end of the range closer to the 200 basis points level. The Fed is on target to achieve its outer limit of 3% over the next 3 years. However, the Fed has also affirmed that the eventual equilibrium rate will still be below the pre-crisis low which is broadly a dovish signal.

Interpreting the CME Fed Watch Tool..

How the data shaped up and what it means for future rates trajectory..


monetary policy

What does the Fed rate action mean for India?

The Fed trajectory on rates is broadly in line with its original guidance. To that extent, it is not likely to have any disruptive influence either on the financial markets in India or even in the currency markets.

The RBI, in its previous MPC meetings, has already shifted its monetary stance to neutral and has even asked markets to prepare for a possible rate hike in India. This benign trajectory painted by the Fed will largely allay these fears and the RBI may have an incentive to shift its monetary stance back to accommodative in its August credit policy.

A rate hike is a signal by the Fed that economic growth is coming back to the US economy. In fact, the Fed has projected full year GDP growth this year at 2.2%. While this is lower than previous estimates, it is still material considering the huge base of GDP in the US.

The big takeaway in the Fed policy announcement could be the tapering of the Fed bond portfolio, which is estimated at around $4.5 trillion currently. The Fed has affirmed that the tapering is likely to be gradual and calibrated keeping enough room for a course change. After the experience of 2013, India would surely find that a sobering thought.

Lastly, the taper could actually reduce the risk of monetary tightness in the US. Normally, in a taper, the Fed will not roll over redemptions. That means liquidity will be sucked out of the system and this normally leads to a hardening of yields. If yields harden without rate hike, then the Fed may consider the size and quantum of rate hikes. That should lead to a slightly less hawkish approach to rates by the Fed and that will surely favour India.

The Fed rate trajectory has surely given Indian markets something to savour. How the RBI reacts to these cues in the next couple of months, will decide how monetary policy evolves in India!