8 mins read . 02 May 2023
As the Federal Open Markets Committee (FOMC) of the US Federal Reserve gets all set to announce its policy statement on 03rd May, the million dollar question is whether the Fed would again hike the rate of interest. For now, the Bloomberg consensus shows that the Fed would hike another 25 bps from the range of 4.75%-5.00% to 5.00%-5.25%. This would effectively translate into an aggregate rate hike of 500 basis points since the Fed started hiking rates in March 2022. However, we need to wait and see, but statements coming from the Fed appear to be crystal clear that they are not yet done with the rate hikes. However, with the recent collapse and bailout of First Republic Bank last week, it remains to be seen if the Fed holds on to its hawkish stance.
When the FOMC meets on the 02nd and 03rd of May, they will have a number of contradictory forces to play. On the one hand, there is consumer inflation that is still way above the 2% target of the US Fed. Secondly, there is the labour data which continues to be very strong and that is keeping consumer spending high. That is preventing a rapid fall in inflation. These two factors call for the Fed to continue its hawkish stance and raise rates further. On the other hand, there are two factors that also call for the Fed to go easy. Firstly, GDP growth in the first quarter of 2023 has fallen sharply to 1.1% as per the first advance estimates. That is sharply lower than the 2.6% growth evinced in the fourth quarter of 2022. Growth pressures are starting to show. The other factor is the banking crisis and the Fed may be inclined to hold rates to give some relief to the bond portfolios of smaller banks.
The CME Fedwatch is more of a market-related indicator. It reflects implied probabilities of future rate hikes based on Fed futures trading on the CME futures exchange. Here, Fed futures prices are used to assess the quantum of rate hikes in each of the future FOMC meetings over the next one year.
Fed Meet | 325-350 | 350-375 | 375-400 | 400-425 | 425-450 | 450-475 | 475-500 | 500-525 | 525-550 |
May-23 | Nil | Nil | Nil | Nil | Nil | Nil | 5.5% | 94.5% | Nil |
Jun-23 | Nil | Nil | Nil | Nil | Nil | Nil | 4.1% | 71.6% | 24.2% |
Jul-23 | Nil | Nil | Nil | Nil | Nil | 0.7% | 15.0% | 64.0% | 20.3% |
Sep-23 | Nil | Nil | Nil | Nil | 0.3% | 7.7% | 39.0% | 42.6% | 10.4% |
Nov-23 | Nil | Nil | Nil | 0.2% | 5.6% | 30.1% | 41.6% | 19.5% | 3.0% |
Dec-23 | Nil | Nil | 0.2% | 4.6% | 25.4% | 39.4% | 23.8% | 6.2% | 0.6% |
Jan-24 | Nil | 0.2% | 3.9% | 22.4% | 37.4% | 26.0% | 8.7% | 1.4% | 0.1% |
Mar-24 | 0.1% | 3.6% | 21.7% | 37.2% | 26.5% | 9.2% | 1.6% | 0.1% | Nil |
May-24 | 8.81% | 25.2% | 34.6% | 22.5% | 7.5% | 1.3% | 0.1% | Nil | Nil |
Data source: CME Fedwatch
How do we interpret this probability table of future rate hikes as culled from the CME Fedwatch? Here are the major takeaways.
Let us finally turn to some key takeaways for India.
In the April policy, RBI had opted to maintain the status quo on rates. Since early 2022, the RBI has hiked rates by 250 bps while the Fed has hiked rates by close to 500 bps. Post the rate hike in May 2023 (assuming the Fed hikes rates), the gap between Indian repo rates and the Fed rates would be just 125 bps, which is the lowest it has been in a long time. The one thing that the RBI must monitor is the risk of monetary divergence. In the past, such divergences have created huge volatility and that is something to be cautious about.
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