The Fed’s hawkish stance was widely anticipated, given that inflation in the US is still raging. However, Fed chairman Jerome Powell’s comments emphasized that interest rates are likely to keep rising in the near future to curb inflation. As things stand, there is a strong possibility of another 75bps hike in November’s Fed meeting.
With that, the likelihood of a pause is thrown out of the window, for now. The implications of the Fed’s approach of fighting against inflation at any cost has naturally shaken investors out of their complacency.
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“The Fed is not taking any chances with inflation and they are prepared to send this economy into a recession. Goodbye soft landing, Wall Street prepares for a hard landing," said Edward Moya, senior market analyst, The Americas, Oanda. A hard landing refers to a significant economic slowdown.
Other central banks are also expected to follow suit with more front-loaded hikes, as they attempt to catch up with the Fed. After all, a rising interest rate trajectory means a stronger US dollar and this in turn means equity assets and emerging markets (EMs) would become less attractive options for foreign investors.
Further, a rapid pace of monetary policy tightening amplifies the risk of an economic downturn. The spectre of a global recession now looms larger than ever, and this is bad news for equity markets.
As this has been the fastest rate hike cycle in decades, a lot of tightening has already taken place and may have yet to work its way through the economy, said Kathy Jones, managing director and chief fixed income strategist, Charles Schwab. “Fed tightening cycles are often characterized by high volatility, especially in riskier segments of the markets. With the Fed moving at a rapid pace, volatility is likely to remain high," she cautioned.
Investors have a lot on their plate. Geopolitical risks linger, while they chew on the outcomes of aggressive interest rate increases. The China slowdown story, the potential for energy rationing in Europe, the strong dollar, and fragile domestic equity and housing markets point to clear recession risks, said analysts at ING in a note on 21 September. “A more aggressive Federal Reserve rate hike profile and tighter monetary conditions will only intensify the threat," they added.
The Indian stock market, though, was largely resilient after the Fed meeting. The key benchmark index Nifty 50 closed Thursday’s session down 0.50%; some key Asian indices have fallen more.
India is better placed than developed markets on some key parameters, including inflation and growth, said Kunal Vora, head of India equity research at BNP Paribas. However, India’s relative strength cannot be fully attributed to de-coupling as a lot of it also has to do with other EMs being less investable now, he said.
Indian markets continue to trade at a premium to its EM peers. “India’s valuation premium to its Asian peers remain near all-time high," said a BNP Paribas report.
“India is not completely immune to global macro-economic risks. As the dollar strengthens, valuation remains elevated and EMs become more investable, foreign institutional investor outflows from India can resume," Vora added.
In short, India’s macro positives are outweighing the negatives right now. However, against the current global economic backdrop, the question then is whether India’s expensive valuations are justified.
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