Just a week ago, traders were seeing a high chance that the US Federal Reserve would hike interest rates at least three times this year, with the first hike expected in September, as inflation remains sticky, above the US Fed’s 2% target.
However, softer-than-expected US jobs data for the month of June has raised expectations that the central bank may not go for aggressive rate hikes this year. As per Reuters, the CME FedWatch tool shows traders now see a 54% chance of a rate hike in September, down from 66% before the jobs data.
Private payroll and nonfarm payroll data for September came significantly below expectations as macroeconomic headwinds hit business sentiment.
ADP’s national employment report showed that private employment in the US rose by 98,000 jobs in June, below expectations of a 1,18,000 rise. Nonfarm payrolls increased by just 57,000 in June, below the expectations of a 1,10,000 rise. Moreover, April and May nonfarm payrolls were also revised down by 74,000.
Softer jobs data may put the US Federal Reserve on the back foot on hiking rates. However, the central bank remains focused on keeping inflation to its target.
Federal Reserve Chair Kevin Warsh last Wednesday emphasised that the central bank is determined to bring inflation back to its 2% target, even as he pointed out that inflation risks have come down after the fall in crude oil prices.
The Fed kept the benchmark interest rate unchanged for the fourth consecutive meeting in June. The next policy meeting is scheduled for 28-29 July.
VK Vijayakumar, Chief Investment Strategist at Geojit Investments, believes that with US inflation remaining high (core inflation at 2.9%) and bond yields (US 10-year yield at 4.46%) inching up, there are expectations of rate hikes from the Fed.
“The Fed Chief Kevin Warsh’s declaration that the central bank will deliver price stability in the US is an indication that the present high inflation rates are not acceptable. However, the Fed chief has also added that inflation expectations have come down. The next inflation data expected on July 14th will largely influence the Fed decision on July 29th,” said Vijayakumar.
Vijayakumar underscored that since crude prices have come down sharply, it is possible that the coming inflation data will show slowing inflation, in which case the Fed may hold rates in July, too. But if inflation persists, one rate hike is possible, if not in the July meeting, in the meeting after that.
Dr Joseph Thomas, the head of research at Emkay Wealth Management, underscored that after the new Fed Chairman took over, there was an expectation that he would go for soft policy, which is quite in alignment with what President Donald Trump always wanted.
However, in the last policy, the Fed left the rates unchanged. Not only that, the Fed Chairman said that inflation is too high compared to the target rate of 2 %, and that the Fed takes price stability or inflation containment as an important objective to be monitored and achieved.
Thomas said the likelihood of a rate hike in the July or Sept policy is very high.
How could US Fed rate hikes impact the Indian stock market?
Experts say a cumulative rate hike of over 50 bps this year may weigh on domestic market sentiment as it will strengthen the US dollar, lift the yields, potentially triggering more foreign capital outflow.
Shrikant Chouhan, the head of equity research at Kotak Securities, said that while a 25 bps hike will not be a matter of concern, a 50 bps hike this year will significantly impact the Indian stock market. Moreover, it will have negative implications for the IT services companies as it may lead to tighter discretionary spending in the US.
According to Vijayakumar, higher rates and yields in the U.S. will be negative for the Indian equity market since FPIs are likely to sell more in India and move money to high-yielding U.S. bonds.
Thomas of Emkay Wealth Management believes that the fears around a Fed hike are not entirely misplaced, as it can also drive monetary tightening in India. Moreover, foreign capital outflow can derail the rupee’s recovery, which will again be negative for market sentiment.
“In terms of its consequences for the domestic economy, the domestic rates may also move in sync with the US rates, and the rupee, which is trying to find its moorings after a host of measures by the government and the RBI, may also come under pressure,” said Thomas.
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