What Janet Yellen is indicating to the world on rates?
In the aftermath of the Jackson Hole Symposium of central bankers, Janet Yellen was hawkish along expected lines. Janet Yellen has admitted that the macros make a very strong case for a rate hike as early as September. So what are the key influencing factors and its implications?
Macros may be in place…
The Fed Chair has rightly pointed out that the US economy seems to be ripe for a rate hike. Unemployment at 4.5% is the lowest in decades. Growth signs are picking up across specific sectors. The only area of concern is the inflation. The Fed has set itself a benchmark of 2% inflation before moving on Fed rate hikes. However, the Fed has already clarified in the past that the rate hike decision will be based on expected inflation and not historical inflation. The Fed is yet to factor in the impact of wage hikes due to full employment. Once that is taken into account, higher inflation may be just round the corner.
Global factors may not matter…
The Fed had held back on rate hikes in the previous policy as it came in the immediate aftermath of BREXIT. One of the likely outcomes of BREXIT was that the UK and the EU were likely to slow down. As a result, the Fed had held back on rate hikes last time. However, the Fed does not exactly see the rate hike as inimical to growth. This is evident from the fact that countries like Europe and Japan have kept rates at negative levels for a long time and yet growth is not visible. Like in December 2015, the Fed may bite the bullet now!
How it will impact FPI flows…
Certainly, global risk-on flows will evaporate rapidly, as we have already seen in this week. This could be a double whammy for countries like India. Firstly, the weakening of risk-on flows is likely to hit emerging markets across the board and Indian markets are unlikely to be spared. Secondly, a possible rate hike will mean that the RBI will halt on rate cuts to ensure that bond yields in India do not turn unfavorable. Like we saw in January 2016, FPI flows are likely to turn negative with negative implications for the value of the INR.
What will the Fed eventually do?
We foresee just one rate hike by the Fed in this calendar year. The US will itself have concerns on this front. Firstly, the rate hike will result in a strong dollar. That will only make matters worse for the US companies that are predominantly export driven. Secondly, the world is awash with liquidity and hence nearly $12 trillion of bonds are giving negative yields. The fear for the US is that a rate hike will lead to a rush for dollar assets in search of alpha. The crowding in of capital may be the big challenge for the US economy!