Top US central banker talks of unwinding the QE programme, raising interest rates
Currency and bond markets turned intensely volatile following US Federal Reserve Chairman Jerome Powell’s statement on Wednesday that a committee will begin considering unwinding of the ongoing quantitative easing programme. Adding to the nervousness of the markets, the Fed indicated the possibility of 50 basis points hike by 2023, which is interpreted as being hawkish.
Yields on the 10-year bond spiked , but closed down 3 basis points at 6.02 per cent. Most other bond yields rose 3-4 basis points, tracking the US benchmark bond yield that jumped 7.5 basis points.
“The Fed’s ‘U’ turn resulted in risk-off trade across the globe. Treasuries and the dollar were in demand again and emerging markets and currencies took a hit,” said Amit Pabari, Managing Director, CR Forex.
The implication of the Fed rate hikes, which can weaken the domestic currency, and the hardening crude oil prices is that inflation could increase in India. The country imports almost 80 per cent of its crude oil requirement.
Another impact of the possible rise in US interest rates for emerging market economies such as India could be that foreign portfolio investors (FPIs) may prefer to invest in the US due to relatively higher risk-adjusted returns.
“In the last couple of months, FPI inflows, especially into initial public offerings, was supporting the rupee. But going forward, this may not be the case. FPIs may start pulling out gradually. Once the Fed starts hiking rates, risk-adjusted rate of return from the Indian market may no longer be lucrative when compared with the US,” said the treasury head of a private sector bank.
Madhavi Arora, Lead Economist, Emkay Global Financial Services, said, “The rupee leads the emerging markets Asia forex pack in losses today as the markets digest the hawkish FOMC with the median dot chart now indicating two rate hikes in 2023. This has helped push the broad dollar up another 0.7 per cent today (currently at 91.65), implying pressure on emerging market currencies, led by high beta ones.”
Pabari said that moving ahead, it would be interesting to watch how Fed communicates about tapering as their next step — ‘Early rate hike’ — is already getting discounted in the market. “But one thing is sure that flight of capital will happen from emerging markets to US treasuries. Not only the RBI, with the fifth largest reserves in the world, will compromise but other EMs will also need to use their reserves.”