US Fed meet: Another rate hike may be a spoiler for Indian markets and gold

After the Reserve Bank of India maintained a status quo for the second straight meeting in June, many investors expect that the US Federal Reserve may also take a break in the upcoming policy meeting this week between June 13 and 14.

Brokerage house Antique Broking believes that another rate hike in the US may be a spoiler for the Indian markets in the near term.

"Recent macro data from the US has led to a sharp upward revision in terms of Fed rate outlook for CY23 (now at 5.0 percent against earlier estimate of 4.6 percent), with an expectation of another rate hike in the June or July policy. Indian equities continue to trade at a premium valuation which may lead to market consolidation given slowing domestic macro, mild disappointment in corporate earnings, risk of populism in the upcoming 2024 general election posing a fiscal risk, moderation in US rate cut expectations," it said.

In its May policy, the US Federal Reserve raised its interest rate for the 10th consecutive time in a little over a year. However, it also dropped a hint that suggested that the current tightening cycle might be ending soon.

In a unanimous decision widely expected by markets, the central bank’s Federal Open Market Committee raised its benchmark borrowing rate by 0.25 bps, taking the rate to a target range of 5-5.25 percent, the highest since August 2007.

According to a Reuters report, Federal Reserve officials in the May meeting, "generally agreed" that the need for further interest rate increases "had become less certain," with several saying that the quarter-percentage-point hike they approved might be the last.

Others cautioned the US central bank needed to keep its options open given the risks of persistent inflation, which is still running at more than two times the Fed's 2 percent target, the report added.

Antique also pointed out that the key takeaways from the US Fed meeting (May 2–3) minutes are: “a) Core goods inflation is easing slower than expected despite easing supply chain constraints; b) Core non-housing services inflation showed some signs of easing in the last few months, but further easing in labor market conditions would be needed; c) Labor market imbalances are diminishing as prime age labor force participation is returning back to pre-pandemic levels and a further reduction in the rate of job opening and quits; d) Extent of effect from tightening of bank credit condition on households and businesses are uncertain; e) Expect recession in 4QCY23 and 1QCY24 followed by moderately paced recovery; f) Suggested retaining optionality and being more data dependent in terms of policy outlook; g) Some participants stressed that the language in post meeting statements should not signal either a rate cut or a further hike in CY23 is ruled out.”

It further noted that the US April PCE (personal consumption expenditure) deflator reading was higher than consensus, which along with sustained demand traction resulted in a sharp upward revision in CY23 Fed rate expectation. Consensus is now factoring in another rate hike of 25 bps in the upcoming June or July policy, followed by just one rate cut in CY23 (possibly in November or December), which could likely lead to a recession in the US in the second half of the calendar year 2023, further stated the brokerage.

Another expert Anthony Heredia, MD & CEO, Mahindra Manulife Investment Management, also does not see the US Fed pausing its rate hike cycle in its June meeting.

The consensus estimate is that of a 25-basis point rate hike. The US inflation and employment numbers still look robust enough at this point in time. However, with one of the largest rate hike cycles in US history taking place, they would probably be more data-dependent while pursuing the future rate trajectory after the June meeting, he said.

Gold Prices

In another report, brokerage house Emkar Wealth Management stated that gold prices have seen support due to the current economic data in the US. The yellow metal now has support levels at $1,970 and $1,990 as the US Dollar softened post the latest job data. The latest data set has led to a belief that the US Fed will take a pause and hold interest rates at current levels, it noted.

"While the Fed Chairman indirectly hinted at the possibility of a pause, the other Fed officials, quite a number of them, sounded like there is enough room for the Fed funds rate to rise even beyond the 6 percent level, from the current range of 5-5.25 percent. The improving labor market and the unemployment levels in the US indicate the underlining strength of the economy. Going forward the action from the US Fed will provide cue and the likely movement of gold prices," it said.

It also pointed out that inflationary pressures may not be completely over for the Fed. While the larger consensus is the central bank may pause in its June meeting, any rise in retail prices may force the central bank to tighten rates. Any hike in rates may also lead to softness in gold prices, added Emkay.

Going ahead, it expects gold to hold well at the support levels, but much would depend on the fortunes of the US economy.

"The first point is that the recession may be a touch and go, and if that is going to be the actual case, then gold will be able to make only limited gains. The recent data from the US is still mixed. Second, there is still no final statement from the Fed on the trajectory of policy rates. It is still to evolve further over the next two FOMC meetings. Third, the buoyancy created by money flowing into ETFs is missing at present. And finally, there will be limited diversification in the existing investment portfolios given the assessment that conditions will be the same across territories, and a diversification away from the US or developed markets is not feasible at this juncture," it explained.

However, it advised that any further dips in gold can be opportunities to buy into.