As expected

The hike in the US Federal Funds rate by 25 basis points on Wednesday had little impact on either the US or world financial markets, indicating that it had already been priced in.

That is no surprise, since the US Federal Reserve had prepared the markets well for the increase, and had indicated also that the rise would be "measured". With US consumer and mortgage debt at record highs, it was unlikely that the Fed would raise interest rates sharply, as that would have serious consequences for consumer demand.

Of course, the US central bank has justified its moderation by stating that it expects the current rise in inflation to be temporary, but many analysts believe that the US is well "behind the curve" in tightening rates. That seems to be borne out by the fact that bond yields in the US have already moved up smartly.

On the other hand, the lower crude oil prices, the rise in US productivity, and keener competition arising out of the emergence of low-cost producers such as China and India are all factors that help keep a lid on inflation.

Nevertheless, there is general agreement that the interest rate cycle has turned, that the Fed will progressively tighten rates further, and that America's honeymoon with low interest rates is coming to an end.

The conventional view is that a rise in US interest rates is the signal for money to flow out of emerging markets. At the very least, it heightens risk aversion, leading to reduced inflows into these markets. Foreign funds have in the last three months sold emerging market equities, while spreads have hardened for emerging market bonds. This has affected all equity and bond markets, and India has been no exception.

More importantly, a rosy outlook for the US markets is by no means certain, with several analysts pointing to the fact that the bounce in the economy has so far largely been the result of massive fiscal and monetary stimulus. The huge current account deficit continues to exert pressure on the dollar, which would make dollar assets unattractive.

However, given the herd mentality of fund managers, it's unlikely that the optimistic scenario for emerging markets would carry much weight in the short-term.

So far as the domestic markets are concerned, it's true that foreign portfolio flows do matter. But, as the balance of payments data for the fourth quarter underline, there are several other sources of inflows, and the country has a comfortable current account surplus.

The pressure on the rupee should therefore ease, once the effect of leads and lags wears off. So far as the bond markets are concerned, there is still enough liquidity in the system, and there's no immediate need to hike domestic rates.

Of course, with growth at 7 to 8 per cent, and with investment demand picking up, there'll be a time when liquidity dries up. Raising rates at that point of time will be entirely healthy, and will reflect the underlying strength of the economy.