Federal Reserve signals rate increase in March, citing inflation and strong job market
|Global developments
While the Fed policy statement was more or less along expected lines, Fed chair L's statements in the press conference were quite hawkish. The Fed policy statement said that with inflation well above 2% and a strong labor market, it would soon (we assume March) be appropriate to raise the federal funds rate. Asset purchases would end in early March. A separately issued statement on balance sheet normalization said that the Fed funds rate is the primary means to adjust monetary policy. The process of balance sheet normalization would commence after the process of increasing the range of Fed funds rate has begun. Balance sheet normalization would happen in a predictable manner by adjusting the amounts of securities being reinvested. Our understanding is that the Fed has prepared the market for a 25bps hike in March. In the press conference Fed chair Powell was quite hawkish. He said there is quite a bit of room to raise rates without hurting jobs. He did not rule out raising rates at every Fed meeting in 2022. He also did not rule out hikes happening in increments of more than 25bps at a time. The hawkishness weighed on risk sentiment and was reflected in price action across asset classes. US equities were up around 2% into policy but reversed to end in the red. Yields at the shorter end of the curve rose 18bps. Yields at the longer end rose relatively less 7-8 bps, causing the curve to flatten. The dollar strengthened as short-term real rates firmed up significantly. The Euro has broken through the support at 1.1250. Commodity currencies have weakened significantly.
Domestic developments
Equities
The Nifty had staged a phenomenal recovery intraday on Monday to end a 5-day losing streak. It recovered to end 0.7% higher at 17277 after printing a low of 16836. Hawkish Fed policy is weighing on risk sentiment in the early Asia session. Shanghai is down 1% and HangSeng is down 2%.
Bonds and rates
The yield on the benchmark 10y ended at 6.65% on Monday. We are likely to see a sell-off in domestic bond markets today given the sell-off in US bonds on a hawkish Fed policy. The bond market is likely to price in a hawkish RBI given a hawkish Fed.
USD/INR
The Rupee had weakened on Monday to end at 74.77 against the Dollar. The weakness continued yesterday in offshore markets. Despite Dollar weakness heading into Fed policy. Post the USD/INR broke the 75 mark in offshore. We may see forwards come under pressure due to the move in US short-term rates. Asian and EM currencies are trading weak.
Strategy: Exporters are advised to cover on upticks towards 75.30 levels. Importers are advised to cover on dips towards 73.80 - 73.90 level. The 3M range for USDINR is 73.80 – 76.00 and the 6M range is 73.50 – 76.50.
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