When the Fed concluded its meeting on the 13th of June, there was little by way of surprise. The Fed futures on the CME were already indicating a 97% chance of a rate hike. So, there was little surprise when the Fed hiked the rates by 25 basis points to the 1.75%-2.00% range. But the key to the Fed policy is not in the rate hike but in the language of the Fed. That is a clearly hawkish signal for the global markets.
Inflation, growth and wages
From the very beginning the Fed had held on to its 3-factor model consisting of inflation, GDP growth and the rate of unemployment. Inflation has crossed the 2% mark and now looks to touch 2.1% in 2019 and 2.4% in 2020. That is clearly a hawkish signal. Inflation could get accentuated by higher crude oil prices and greater consumer spending due to greater spending power. Then we come to growth. The US GDP growth is likely to cross the 3% mark in the next couple of quarters and that is also likely to be inflationary. The tax cuts combined with the infrastructure thrust of $1 trillion are likely to have a huge impact on GDP growth. In fact, the GDP growth is likely to end up much beyond the World Bank target of 2.8% for the US economy. Lastly, the labor market continues to show buoyancy. With unemployment at a multi-decade low of 3.8% and veering towards 3.5%, the rate hike was always on. Fed has also indicated that wage hikes could follow!
Did you read the language?
More than the evaluation of the data, it is the outlook that was really hawkish. The Fed had guided for the inflation and growth to continue its upward trajectory for the next few quarters. In fact, GDP growth could actually surprise on the upside. Inflation is likely to be demand pull and cost push. On the cost-push side, apart from the oil prices, the higher import duties on imports will also have an impact. While the higher revenues will somewhat compensate for the huge trade deficit that the US is running, the truth is that higher input costs will also push up inflation. The Fed has clearly guided for at least 2 more rate hikes in 2018 and 3 more in 2019. That will take the rates to 3.25% by the end of calendar year 2019.
Should India be worried?
A stronger dollar could impel the RBI to go for at least 2 more rate hikes this year. Also the FPI outflows could be a worry, although that is likely to come down if the RBI raises NRI bonds and shores up the rupee. But the big positive for the Indian economy is that growth is returning to the US and that is good news. Normally, Indian market have benefited from a strong dollar and strong US growth. That means weak gold and a natural investor preference for equities. Notwithstanding, short term worries, India should stand to benefit from the Fed rate hike!