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US Fed raises interest rate by 75 bps for third consecutive time and continues its plan to shrink the Balance sheet

ICICI Securities 23 Sep 2022

Key Highlights:

• The US Federal Reserve decided to raise interest rate by 75 bps to a range of 3.00-3.25% and signalled intentions to keep monetary policy tight. Federal Open Market Committee decided to continue its balance sheet reduction as announced in May 2022

• US Federal Reserve officials project interest rate to rise to 4.4% by the end of this year and 4.6% in 2023. The US Federal Reserve slashed its growth forecast and expects inflationary pressure to prevail this year

Economic Projections:

• US Federal Reserve in its economic projections revised lower its GDP growth outlook for 2022 to 0.2% compared to June estimate of 1.7% and even downgraded its growth forecast for 2023 to 1.2% compared to June projection of 1.7%

• The bank raised its inflation forecast to 5.4% for 2022 compared to June projection of 5.2%. Fed hiked its core PCE inflation estimate for 2022 to 4.5% from 4.3%

• The bank expects interest rates to rise to 4.4% in 2022 compared to June estimate of 3.4% and 4.6% in 2023 compared to estimate of 3.8%

Impact on Dollar Index and Rupee:

The Dollar Index may continue with its positive bias as the US Fed decided to raise interest rate by 75 bps, for a third consecutive month and signalled that it would continue to lift rates this year at a most rapid pace to combat inflation, which is running hot. Additionally, the US Federal Reserve announced it would continue with its plan to shrink its $9 trillion asset portfolio, which plays an important role in firming stance of monetary policy. Additionally, In this year two policy meet are pending, we may see a 75 bps rate hike in November meet and 50 bps in December meeting.

Additionally, other major central banks across the globe are likely to lag behind in tightening monetary policy high inflation and dwindling economic growth. As long as the Dollar Index sustains above 107.50 level it may continue to rally till 113/114 levels.

US$ vs INR, as long as it sustains above 79.00 it is likely to depreciate till 81.50 in coming month amid strong dollar and concern over widening of the trade deficit. However, possible RBI intervention in forex market to curb volatility may prevent sharp rupee depreciation. Additionally, FIIs have turned net buyers after a long period of time. Moreover, the market expects inflows up to $30 billion in 2023-24 if JP Morgan includes Government of India bonds in its index, which should help the rupee to show continued resilience.

Guidance on Inflation and Economic activity:

• Fed Chair Jerome Powell said the economy has slowed from historically high growth rates of 2021. Recent indicators reflect modest growth of spending and production. Activity in the housing sector has weakened significantly, in large part, reflecting higher mortgage rates

• The labour market continued to strengthen and is extremely tight. Unemployment rate is near a 50-year low, job vacancies are near historical highs and wage growth has stayed elevated. Over the past three months, employment rose by an average of 378,000 jobs per month. FOMC participants expect the labour market to come into better balance over time, easing the upward pressure on wages and prices

• US Federal Reserve Chairman Jerome Powell said inflation remained well above longer run goal of 2%. Price pressures remain evident across a broad range of goods and services. Although gasoline prices declined in recent months, they remain well above year-earlier levels, which has boosted prices for energy and food and has created additional upward pressure on inflation

Monetary Policy statements:

• Recent indicators point to modest growth in spending and production

• Job gains have been robust in recent months while the unemployment rate has remained low

• The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and is weighing on global economic activity. The committee is highly attentive to inflation risks

• The committee seeks to achieve maximum employment and inflation rate of 2% in the longer run. In support of these goals committee decided to raise target range for the federal funds rate to 3.00% to 3.25% and anticipates that ongoing increases in the target range will be appropriate

• In addition, the committee will continue reducing its holdings of treasury securities and agency debt and agency mortgage-backed securities, as described in the plans for reducing the size of the Federal Reserve’s balance sheet that were issued in May

• The committee is strongly committed to returning inflation to its 2% objective

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.

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