Fed minutes suggests slower rate hikes

Latest Fed minutes indicate the rate hikes may taper to 50 bps in the December .

The US Central Bank (Federal Reserve), which just announced the minutes of the last FOMC meeting, has finally indicating that it would slow down on rate hikes. In the last 4 meetings, the FOMC had raised rates by 75 bps on each occasion. Overall, since March 2022, the Fed has increased the interest rates in the US by 375 basis points from the range of 0.00%-0.25% to the range of 3.75%-4.00%. Now, the latest Fed minutes indicate that the rate hikes may taper to 50 bps in the December Fed meet followed by a few more hikes of 25 bps each in year 2023. Overall, the rates could end up anywhere between 5% and 5.5%.

Inflation is still a worry in the US

In the month of October 2022, US inflation came in at 7.7%. Inflation has come down in the last few months, but with 10-year bond yields in the US at 3.8%, we are still talking of negative real bond yields of -3.9%. That is hardly a sustainable scenario. It also means that, even as the Fed slows down on its rate hike momentum, the fight against inflation will have to continue well into 2023. 

There are 4 broad takeaways from the Fed minutes.

i. The Fed is not done with rate hikes and there could be another 100 to 150 basis points of rate hikes. The street expectation is of a 50 bps rate hike in December with the balance spread across the first half of 2023.
ii. The Fed has underlined that, contrary to the expectation of a terminal rate of 4.6% as indicated earlier, the new terminal rate would be above 5%. CME Fedwatch is hinting at Fed rates terminating between 5% on the lower side and 5.50% on the upper side.
iii. On the positive side, the Fed has given an indication that it would be considering multiple factors like growth impact, lag effect of rate hikes and the liquidity impact before deciding on the quantum and pace of future rate hikes. It has specifically stressed that it would also consider the cumulative tightening before any decision is made. 
iv. CME Fedwatch also hints at an outside possibility of rate cuts by the Fed in the second half of 2023, if the impact of the rate hikes on inflation is oversized and is seen to be steadily moving towards the 2% inflation mark.

What the Fed minutes mean for Indian markets?

The US markets may not have given a thumbs up to the Fed minutes but it appears to be pleased. Indian markets have reasons to cheer on three fronts. Here is why. Firstly, if the Fed slows on rate hikes in December and beyond, it would put less pressure on the RBI to hike rates. In that case, the RBI can settle for a much lower peak repo rate, which would be value accretive for Indian markets.

Secondly, at the current rate differentials between the US and India, the FPI flows are likely to be risk on. India still has an advantage due to positive real rates, unlike the US where real rates are negative. The latest minutes should ensure that FPI flows into India remain positive. Lastly, reduced hawkishness on the part of the Fed means the dollar index should peak out and that reduces the risk of further weakness in the rupee. The Fed minutes should be seen as positive for Indian markets overall.