Amid soaring inflation in the United States, at 40-year high, and unabated worries over Russia and Ukraine war, the US Federal Reserve is all set to hike interest rates at the upcoming FOMC (Federal Open Market Committee) meeting. Markets are expecting a quarter point increase, making it the first time since 2018 that the US Fed will hike rates. Fed chair Jerome Powell indicated recently that he will back a 25 basis points hike, and the broader market consensus is also in line with his view. According to CME Group’s FedWatch tool, 97.3% of the participants backed a 25 basis point hike in the April meeting. However, if the Fed decides to hike rates faster than expected in the next FOMC meeting, markets may react negatively.
Considering the fact that inflation is at a 40-year high, and that core PCE inflation is at a 30-year high, makes it imperative for the US Fed to raise rates and steadily tighten monetary conditions, Prasenjit K Basu, Chief Economist, ICICI Securities told FinancialExpress.com. The Fed would aggressively raise interest rates this year, starting at the March FOMC meeting, and will be obliged to raise the Fed Funds rate at every one of its remaining meetings this year, he said. Effectively, this will take the target Fed Funds rate to 1.75% by the end of 2022 – implying there will be at least one hike of 37.5 bps to normalise the rate, Basu added.
Inflation amid heated supply chain
Already heated supply chain disruptions have been further exacerbated by the conflict between Russia and Ukraine, and since then oil prices have risen by over 25%. The region is one of the largest exporters of commodities and energy globally, particularly for oil, gas, commodities, metals and wheat. “The supply-side disruptions, the recent surge in oil prices is going to have an impact on the prices in the short to medium term,” Arun Malhotra, Founder, CapGrow Capital Advisors said.
“If we have persistent disruption to energy and food supplies, that’s going to put upward pressure on inflation,” Brett Ryan, senior US economist at Deutsche Bank told Reuters. “That … means consumers will have less income to spend on other goods and services, and that typically is what slows the economy and presents recession risks.”
Markets may react negatively if Fed raises rates faster than expected
Pandemic, war and inflation have complicated matters for the US Fed, Deepak Jasani, Head of Retail Research at HDFC Securities said, adding that traders will look for indications about the pace of future rate hikes as the meeting concludes. “Markets anticipate a 25 basis point rise at this meeting, but pricing has risen to indicate a 70% chance of a larger 50 basis point hike at its subsequent meeting in May, due to concerns about inflation,” he said. “The US Fed could raise rates four to seven times in the next year or two to curb economic growth depending on the evolving situation. The US Fed has never raised rates with the yield curve this flat and volatility so high,” he added.
Globally markets have been expecting the US Fed to raise rates and hence this is partly discounted, although if the rate hikes are faster and sooner than expected or its indication is available in its statements, the global markets could react negatively, Jasani said.
Political challenge for Joe Biden
Rising inflation will also be a cause of concern for the US President Joe Biden’s administration, who will be facing mid-term elections in November. ICICI Securities’s Basu said even though the US will not be significantly affected by the Russia-Ukraine war since it is currently a net exporter of oil and gas, it will instead be a beneficiary of higher oil prices. “High gasoline prices at the gas stations will be a big political challenge for President Biden and the Democrats at the November 2022 mid-term elections, so they have a strong incentive to bring headline inflation down,” he added.
The FOMC meeting is scheduled for Tuesday and Wednesday, and the markets will know the monetary policy direction of the US central bank by Wednesday, Washington time.
