The prospects of Fed rate hikes will not have a long lasting impact on the Sensex, Nifty, INR and 8.40% 2024 government bond as India’s macros are improving and this will provide natural protection to domestic assets. Read our analysis “Why the INR will withstand USD strength”
The FOMC (Federal Open Market Committee) forecast that the Fed Fund rates will be at 1.375% by end 2015 in its September 2014 meeting that ended on the 17th of September. The Fed Fund futures that trades on the CME (Chicago Mercantile Exchange) predicts with a 74% probability (up from 64% pre FOMC meet) that the first hike will happen in July 2015. Fed Fund rate is at levels of 0% to 0/25% at present and this level has been held since January 2009.
The Fed cut its asset purchases by USD 10 billion to bring it down to USD 15 billion a month from USD 25 billion a month. Asset purchases have come off from USD 85 billion a month seen in December 2013. Fed will end its asset purchase program in October 2014.
The Fed Chair Janet Yellen guided markets to extended period of low rates even as the US economy is on the growth path with unemployment rate at 6.1%, down from 6.7% levels seen in January 2014, GDP growth for second quarter 2014 at 4.2% and various gauges from consumer confidence to retail sales showing higher confidence in the economy. Read our Economic Data Analysis for September 2014 for US Economy Data Analysis.
The Fed believes that the economy still requires low rates to continue on its growth path and this is possible as inflation has consistently stayed below Fed’s threshold level of 2%.
The market reaction to the Fed statement was higher USD, stable equities, higher bond yields and lower commodity prices. The USD index that tracks a basket of six major currencies, closed at almost decade high levels of 84.74 even as the Euro fell to one and half year lows and the Yen fell to multi year lows. The prospect of rate hikes by the Fed even as ECB and Bank of Japan maintain ultra loose policy is driving the USD higher.
US equities ended marginally positive on hopes of improved US economy while US five and ten year treasury yields closed higher by around 4bps at levels of 1.84% and 2.62% respectively. Treasury yields have risen by 28bps over the last one month.
Commodity prices fell on stronger USD, with oil prices down by close to 1% and gold prices down by 0.5%.