 "Federal Reserve Chair Janet Yellen gestures as she answers a question during a news conference in Washington")
Bulls on Dalal Street have got used to a benign monetary policy by the world's major central banks, especially that of the US Federal Reserve (US Fed). But, there is a strong likelihood of bulls getting caught on the wrong foot during the forthcoming Fed meeting on September 21 (Wednesday, US time).
Low interest rate in the US has forced global investors to search for yields leading to large capital flows in high-yield markets such as India and other emerging markets. This has fuelled a bull run on Dalal Street, which could be cut short if the Fed listens to the leading economic indicators in the US and global financial markets.
For instance, the one-year London Interbank Offered Rate for dollar, known as Libor, is inching up steadily and is now at nearly seven-year high. One-year Libor loan in dollar now comes at an interest rate of around 1.5 per cent against 1.15 per cent at the beginning of the current calendar year and 0.85 per cent a year ago. Libor had made a record low of 0.55 per cent in October 2014.
The federal funds rate is mostly relevant for the US economy, as it represents the rate at which highly creditworthy US financial institutions trade balances held at the Federal Reserve, usually overnight. The federal funds rate is set by the US Federal Reserve. Libor represents a benchmark rate that leading global banks charge each other for short-term loans. Unlike the federal funds rate, Libor is determined by the equilibrium between supply and demand on the funds market, and it is calculated for five currencies and different periods ranging from one day to one year.
During the previous rate cycle in 2003, Libor had begun to rise two months before the actual rate hike by the US Fed. The last rate hike by the Fed in December 2015 was preceded by a gradual rise in Libor rate. This was the first rate hike in nearly a decade. In the US, the broader economy is showing signs of being ready for a rate hike. The core consumer price inflation (CPI) is now above the Fed target rate of two per cent while the US economy is nearing full employment.
The core CPI in the US, that excludes food and energy prices, rose to 2.3 per cent at the end of August against 1.8 per cent a year ago. Core inflation had hit a record low of 0.6 per cent during October 2010. Meanwhile, the US economy is nearing full employment, with unemployment rate down to 4.9 per cent, lowest since November 2007.
A Reuters poll of 100 economists last week indicates 70 per cent probability of a rate hike by the December. In last month's poll, the probability was 57.5 per cent. A majority of economists expects the fed funds rate to rise to 0.5-0.75 per cent in the fourth quarter from 0.5 per cent currently.
"It's tough to pre-empt a rate hike by the US Fed but the Indian economy seems more prepared than other emerging markets. There could be some negative reaction in stocks and currency markets but it would be orderly and quite manageable," says Devendra Pant, chief economist and head of public finance, India Ratings & Research.
Equity bulls, however, rule out any hike in the immediate term, particularly in the Fed's Wednesday meeting, citing its negative consequences for the global economy. "Stocks markets are up all over the world, which shows traders are betting on a status quo by the Fed in its next meeting. Fed will not risk convulsion in the global economy by raising interest rate at the current juncture", says G Chokkalingam, founder and chief executive, Equinomics Research & Advisory.
