The US Federal Reserve has increased interest rates once again by 25 basis points, 12th hike in a row since the Fed started hiking interest rates in June 2004, thus taking the benchmark rate to 4%. The stance of the monetary policy has also been maintained with the indication that interest rates are likely to continue to rise at a 'measured' pace and the mention about inflation expectations, which according to the Fed, remains contained.
On the US economy, the Fed has commented that 'Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. The cumulative rise in energy and other costs have the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained'.
It must be noted here that a hike in interest rates basically affects 3 broad categories i.e. industry, consumers and markets.
* Industry: Higher interest rates would increase the borrowing costs for corporates thus increasing their cost of expansion and the gestation period of their project making the relative returns that much less lucrative.
* Consumers: A hike in interest rates would make the existing/future repayment/borrowing for the consumers also expensive in terms of loans (housing, personal) thus adversely affecting their spending ability.
* Markets: A substantial rise in interest rates would have an adverse impact on corporate profitability, thus making stock market returns that much depressed. This could entice investors to look for safer investment avenues like fixed income instruments as these would now offer a higher interest return. Further, debt markets are also affected as bond prices correct to align to the higher interest rates.
With respect to the implications of this move on the Indian stock markets, as we have maintained before, equity money flows into emerging markets like India could be impacted in the medium term. While we continue to be strong believers of the 'India story' from a long-term perspective, the recent slowdown in FII inflows does point to the fact that it may not be an easy ride for the Indian stock market this fiscal. Therefore, investing in stock markets on the belief that FIIs will continue to pump in money into India is fraught with risk. To that extent, one has to be cautious.
On the US economy, the Fed has commented that 'Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. The cumulative rise in energy and other costs have the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained'.
It must be noted here that a hike in interest rates basically affects 3 broad categories i.e. industry, consumers and markets.
* Industry: Higher interest rates would increase the borrowing costs for corporates thus increasing their cost of expansion and the gestation period of their project making the relative returns that much less lucrative.
* Consumers: A hike in interest rates would make the existing/future repayment/borrowing for the consumers also expensive in terms of loans (housing, personal) thus adversely affecting their spending ability.
* Markets: A substantial rise in interest rates would have an adverse impact on corporate profitability, thus making stock market returns that much depressed. This could entice investors to look for safer investment avenues like fixed income instruments as these would now offer a higher interest return. Further, debt markets are also affected as bond prices correct to align to the higher interest rates.
With respect to the implications of this move on the Indian stock markets, as we have maintained before, equity money flows into emerging markets like India could be impacted in the medium term. While we continue to be strong believers of the 'India story' from a long-term perspective, the recent slowdown in FII inflows does point to the fact that it may not be an easy ride for the Indian stock market this fiscal. Therefore, investing in stock markets on the belief that FIIs will continue to pump in money into India is fraught with risk. To that extent, one has to be cautious.