US Fed Policy Preview: What are the markets expecting?

Equity markets are turning choppier by the day as they prepare for the US Federal Reserve’s two-day monetary policy meeting. The benchmark indices, for instance, fell over 1% in the intra-day trade yesterday, but ended near flat-line.   

Moreover, over the past six months, the S&P BSE Sensex and the Nifty 50 have slipped around 5 per cent on the bourses amid expectations of rate hikes by global central banks due to the ongoing Russia-Ukraine war and historically high inflation.

Against this backdrop, all eyes are on the US Fed meeting, which begins later today. The outcome might result in a 50-basis point rate hike in the world’s biggest economy -- its biggest hike since 2000. Moreover, it could also be the first time in 16 years that the US Fed officials will hike borrowing costs at two consecutive meetings.

Analysts expect the US central bank to announce plans to start shrinking its near 9 trillion dollar bond portfolio at a likely pace of 95 billion dollars a month. If so, that would be nearly twice as fast as the previous time officials delved into trimming the money supply in 2017. 

Speaking to Business Standard, Narendra Solanki, Head- Equity Research (Fundamental), Anand Rathi Shares & Stock Brokers, says markets are pricing in 50 bps rate hike, as US Bond market indicates expectation of steeper rate hike. Indian market, however, haven’t priced in more than 50 bps hike, and there could be mispricing in the Indian markets, he indicates. 

Concurring with Solanki, Dhananjay Sinha of JM Financial believes that riskier asset classes could be in for a volatile phase as they haven’t priced in elevated rates yet.

According to Dhananjay Sinha, Managing Director & Chief – Strategist, JM Financial Institutional Securities, today investors will track if the Fed is more hawkish than expected. He said the likelihood of steeper Balance Sheet tapering is high, but what is not known is the impact of Balance Sheet normalisation on asset prices across equities, fixed income, commodities etc.

He pointed at the high volatility in fixed income markets and says that equity markets have modest expectations regarding therate hike. The impact of liquidity normalisation will be seen more on risk assets.

So, how should investors position themselves in such a market?

According to analysts, markets could see a knee-jerk reaction on the downside if there is a 75 bps rate hike in May, or faster-than-expected hikes throughout 2022. In the long-term, domestic markets may resume their uptrend.

Jyotivardhan Jaipuria of Valentis Advisors points out that the US Fed hiked rates 17 times by 25 bps each in the 2004 to 2006 cycle. During the period, Nifty went up 99.1%, though Dow Jones went up only 7.2%.

During the 2015 cycle, the US Fed hiked rates by 2.25%, when the Nifty went up by 40.1% and Dow Jones rose 31.4%.

Given this, analysts say investors should 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.

Apart from the US Fed’s meeting, developments around rising Covid-19 cases in China, and the Ukraine-Russia war will be tracked by global markets today. Back home, domestic markets are shut on Tuesday on account of Id-Ul-Fitr.