Is the US Fed rate hike always bad for equity markets? What analysts say

The prospects of a faster-than-expected rate hike by the US Federal Reserve (US Fed) coupled with rising inflation that hit a four-decade high of 8.5 per cent in March 2022 in the US amid the ongoing Russia – Ukraine war have cast their shadow on global equity markets. In the last six months, the frontline indices – the S&P BSE Sensex and the Nifty 50 – have dropped around 5 per cent each mostly owing to these two developments.

The US central bank, said analysts at Rabobank International, is already in inflation-fighting mode. The personal consumption expenditure (PCE) deflator – a measure of inflation based on changes in personal consumption – reached 6.6 per cent in March, well above the US Fed’s 2 per cent target. The core PCE deflator, Rabobank said, was 5.2 per cent in March, suggesting that a return to target is not in sight. In terms of the CPI, it looked even worse: 8.5 per cent headline inflation and 6.5 per cent core inflation in March.

GRAPHIC 1: Return from first rate hike on June 2004

“The Fed is likely to look through the disappointing GDP (gross domestic product) growth figure and conclude that consumption and investment remain robust, while inflation has skyrocketed. Consequently, at the next meeting, on May 3-4, the US Fed is likely to take the next rate step and announce balance sheet reduction. At the May meeting, we expect a 50 basis points (bps) rate hike and the launch of balance sheet reduction,” wrote Philip Marey, senior US strategist at Rabobank International in a recent report.

GRAPHIC 2: Return from first rate hike on Dec 2015

But are the rate increases necessarily bad for markets? 

While the general consensus is of 6-7 rate hikes this year by the US Fed, there are some who expect lower rate hikes and a slowdown in the economy. That said, analysts expect the equity markets to recover soon after a knee-jerk reaction, if any, to the hike in rates and cutting the balance-sheet size.

“In the 2004 to 2006 cycle, the US Fed hiked rates 17 times by 25 bps each. During the same period, Nifty went up 99.1 per cent though the Dow Jones (DJIA) went up only 7.2 per cent. During the 2015 cycle, which was more sober, the US central bank hiked rates by 2.25 per cent. Markets went up during this period, too, with Nifty rising 40.1 per cent and DJIA rising 31.4 per cent. However, in both these cycles, we have seen markets correct initially in the first few months,” said Jyotivardhan Jaipuria, founder and managing director at Valentis Advisors.

WATCH VIDEO: Will markets absorb Fed's half-point whiplash?

2022, said analysts at Invesco Mutual Fund, may pan out as a year of two halves wherein the first half could witness volatility as markets adjust to emerging geo-political scenario, higher inflation and hence normalizing of central bank’s policies. 

“Post the initial risk-off, equity returns hold the scope to accelerate in 2023 and beyond. We suggest investors use periods of volatility to gradually increase allocation to equities to benefit from healthy earnings growth that can unfold over the next two - three years," they said in a recent report.



===================

Twitter: @Pun_ditry