Fed rate hike: Analysts expect markets to rise after initial correction

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 a shadow on global equity markets. In the past six months, India’s frontline indices — the S&P BSE Sensex and the Nifty50 — have dropped around 5 per cent each, largely because of these developments.

The American central bank, said analysts at Rabobank International, is already in an inflationfighting 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 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.

“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 a 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.

But are the rate increases necessarily bad for markets?

While the consensus is of 6-7 rate hikes this year by the US Fed, there are some who expect fewer rate hikes and a slowdown in the American 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 of 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, the Nifty50 went up 99.1 per cent though Dow Jones (DJIA) went up only 7.2 per cent. During the 2015 cycle, which was relatively sobre, the US central bank hiked rates by 2.25 per cent. The markets went up during this period, too, with the Nifty50 rising 40.1 per cent and DJIA rising 31.4 per cent. However, in both these cycles, we have seen the markets correct initially in the first few months,” said Jyotivardhan Jaipuria, founder and managing director at Valentis Advisors.

CY22, said analysts at Invesco Mutual Fund, may pan out as a year of two halves, wherein the first half witness volatility as the markets adjust to the emerging geopolitical scenario, higher inflation, and hence normalising of central bank’s policies. “After 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.