US Interest Rates: Amid rising crude oil prices, thanks to the renewed tensions between the US and Iran, and heightened concerns of inflation, all eyes are on the US Federal Reserve, which will announce its monetary policy on Wednesday, 16 September, along with the updated economic projections, which include the Fed Dot Plot.
The US Federal Reserve is widely expected to raise interest rates by 25 basis points on Wednesday, given the rise in inflation. The worst is that inflation is expected to remain elevated in the near future because of higher energy prices amid the ongoing conflict between the US and Iran.
In its last policy meeting, the US central bank kept benchmark rates unchanged in a target range between 3.5% and 3.75% for the fifth consecutive policy. However, three of the 12 members of the Federal Open Market Committee (FOMC) voted for a 25 basis point hike at the July meeting, hinting at growing discomfort among policymakers over inflation. It was the first time since September 2016 that three policymakers dissented with a unified view about the direction of interest rates.
What can the Fed do on Wednesday?
Most experts believe the central bank will go for a 25 basis point hike this time after maintaining a prolonged pause.
The Fed’s favoured gauge of inflation- the US personal consumption expenditures (PCE) price index- increased by 3.7% year-on-year in July, above the Fed’s long-term 2% inflation target for 65 straight months. August PCE prints are due on 30 September.
Meanwhile, US CPI for August rose 3.4% year-on-year and 0.3% month-on-month, bolstering prospects for interest rate hikes.
“Anyone who was hoping for a cooling – or at least moderation – of core CPI will be sorely disappointed. With a 0.3% month-over-month increase in core CPI, the Fed now finds itself with its back against the wall,” Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management, noted.
“There’s no guarantee that the Fed will hike next week, but it’s hard to see how the central bank can justify leaving rates on hold. What is more interesting is whether the stock market shakes off the threat of higher interest rates and continues to rally in the face of rising oil prices, higher short-term rates and even higher long-term rates,” said Zaccarelli.
“An acceleration in core CPI is likely to push the Fed to hike. Markets are pricing in a 70% probability of a hike at the moment, with a hike in October being priced in fully,” said Madhavi Arora, Lead Economist, Emkay Global Financial Services.
“A Fed hike would follow on the heels of the ECB, which raised its key interest rates by 25 basis points on 10 September, with the BoJ also widely expected to hike on 18 September. A global rate tightening cycle (albeit possibly a shallow one) looks imminent,” Arora said.
How will the Fed’s policy decision impact stocks, gold, and the rupee?
According to Justin Khoo, Senior Market Analyst – APAC at VT Markets, a US Fed interest rate hike on 16 September would likely pressure risk assets initially, although the bigger market driver will be what the Fed signals about the path ahead.
“For stocks, a 25-basis-point increase would raise financing costs and could put upward pressure on discount rates, which is generally negative for valuations, especially in growth sectors. However, if the Fed signals that this is a one-off move rather than the start of another hiking cycle, the sell-off may be limited,” said Khoo.
Khoo added that gold could weaken if the hike pushes real yields and the US dollar higher, increasing the opportunity cost of holding the metal. A more aggressive Fed outlook would strengthen that pressure.
The Indian rupee, according to Khoo, could also come under pressure if higher US yields strengthen the dollar and reduce the relative appeal of emerging-market assets, particularly if investors begin to price in further Fed tightening.
V K Vijayakumar, Chief Investment Strategist, Geojit Investments, believes a Fed rate hike will be negative.
“It will be a negative, as the market has not fully discounted it. With the 10-year yield at 5% in India specifically, and generally for equity markets worldwide, a 10-year yield at 5% will be a more negative,” said Vijayakumar.
Vijayakumar believes the rupee may come under some pressure, but not much, because we now have adequate foreign-exchange reserves.
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