Brokerage firm Emkay Global Financial Services is of the view that the US Fed will hike rates by 75 basis points (bps) on September 21, but 100bps is also a possibility.
Consistently-increasing market re-pricing of the Fed since the Jackson Hole (JH) conference and the searing August inflation print implies that markets now expect a 70bps+ higher terminal rate (4.5%) than that projected on the Fed’s last dot-plot, said the brokerage firm.
Emkay highlighted that recessions are strong disinflationary agents and, technically, inflation is a lagging indicator of recession, as seen from most US inflation cycles since the 1950s.
Thus, while disinflation is imminent, as and when the economy dips, its non-linearity implies that the monetary policy will soon turn highly restrictive.
“While the labour market (and corporate profits) has proven surprisingly resilient so far, we believe the Fed will need to continue tightening the policy till it is confident of some slack coming back into the labour market – and, as such a point is uncertain and given the lags between rate hikes and economic activity, the incremental hikes from end-CY22 may be lower, assuming the labour market starts to materially cool down in 1QCY23,” said Emkay.
However, the brokerage firm added that this also means near-term front-loading continues and the hike cycle moves beyond CY22.
“Watch for 75bps or higher hike and a hawkishly revised dot plot that pushes against expectations of easing next year. The guidance is likely to get tighter if the Fed announces a hike of 75bps versus 100bps. Nevertheless, it is ‘goodbye’ to the “low-for-long” strategy that many market participants have been raised on,” said Emkay.
Asian central banks, including the RBI, have been defending their currencies and dipping into reserves to plug emerging BoP deficits.
Emkay pointed out that India’s massive forex (FX) defence amounting to more than US$100bn estimated since Oct-21 (spot+ forwards) makes it a near-outlier in the Asia FX fall.
“So the war chest is falling faster than the pace of the war fading. We have been suggesting the FX intervention strategy for the RBI will need to be revisited for reducing emerging bilateral imbalances. Dislocation in forward rates, falling FX cover, still-high commodity prices, limited exchange rate pass-through to inflation and elevated rupee valuations may call for the RBI to re-orient its FX intervention strategy,” said Emkay.
The brokerage firm believes the RBI will eventually let the exchange rate adjust to new realities, albeit in an orderly manner, letting it act as an automatic macro stabilizer to the policy reaction function.
Regarding the upcoming RBI MPC policy, the brokerage firm thinks the terminal rate may not cross 6%, plus an estimated de-facto hike of nearly 50bps owing to RBI’s QT, i.e., banking liquidity tightening.
Emkay believes the reaction function of RBI and most emerging markets (EMs) would be tied to the extent of financial-market disruptions and volatility post the FOMC flow into EM assets.
“We would wait for FOMC to play out, before changing our call on the RBI. We maintain inflation will mildly undershoot RBI expectations in FY23 (Emkay: 6.5%; RBI: 6.7%). A supposedly slower RBI hike cycle to an estimated neutral rate versus the Fed’s highly restrictive rates would nonetheless call for painful adjustment, either in FX /rates markets or in both, possibly disproportionately,” said Emkay.
Disclaimer: The views and recommendations given in this article are those of the broking firm. These do not represent the views of MintGenie.
