US inflation has been rising

In the last few Fed policy statements, the FOMC had abstained from hinting at rate hikes. However, it had consistently issued warnings about rising inflation and growth pressures. It had already hinted that it would not be possible to hold on to zero rates of interest for too long. In the June policy statement, the Fed actually gave a trajectory with the Dot Plot chart indicating 50 bps spike in rates by end of 2023 and gradually after that. Not surprisingly, the US bond yield spiked and Dow cracked sharply lower. 

First taper, then rate hike

One thing the Fed highlighted in its June statement was that the taper would precede the actual rate hike by a year. That essentially meant that if the rate hikes of 50 bps had to happen by 2023, then the tapering of the fund buying will have to start somewhere around late 2021 or early 2022. That was likely to create a liquidity disruption in the US and the global markets. That was seen in the US bond yields that spiked and the broad-based Dow Jones index which corrected sharply. The taper will be of greater interest to the capital markets. 

Not much changes for RBI

The big concern was that the signals of rate hike and a likely taper would impact liquidity flows into Indian markets. Let us look at the taper first. It is true that the taper warnings could take some speculative sheen off the markets but it would really amount to little else. Secondly, the rate hikes may not mean much to the RBI as its first priority now is to get the economy out of de-growth morass. That would mean; rates must remain at record low levels for much longer. Also, the inflation may taper once crude tapers and hence real rates of return would not as big a problem as is made out. Now for the positive side. 

Don’t ignore US growth story

In an interesting study done some years ago, it was found that rates hiked by the Fed had a short-term negative effect on global markets. However, when the rate hikes are growth driven, the other benefits in terms of business growth and profit enhancement, more than out-weigh the impact of the rate hike. Thus, it was observed that over the next 2-3 years, the calibrated hikes actually helped global markets eliminate the speculative froth and grow in real terms. There are two things to note. Firstly, even if the US were to hike rates, India would diverge its monetary policy from the US to boost growth. Secondly, the US growth story will be value accretive to Indian markets, which is better!