Investors in the international bond and equity markets were initially concerned by the US retail inflation print for June, which reached a 41-year high and was published on July 13.
Consumer prices rose at a 9.1 per cent annual rate, far exceeding expectations. This increased market scepticism that the US central bank is seriously lagging in its efforts to rein in runaway prices.
The market’s reaction was to quickly factor in the historically unlikely scenario that the US Federal Reserve will raise interest rates by 100 basis points at its meeting later this month, to 2.5-2.75 per cent from 1.5-1.75 per cent. One basis point equals 0.01 per cent.
However, for investors, a percentage point increase in US interest rates will have an impact not only on the US economy but also on the global economy, due to the impact on US imports if the US economy enters a recession.
“Aggressive Fed (interest rate hikes) will drive us into a recession by year-end,” famous hedge fund investor Bill Ackman tweeted. Currently, market participants are pricing in three rate hikes of 100 basis points (bps) each in July, September, and December, raising the Fed fund futures to 3.75-4.0 per cent by the end of the year.
The Fed’s own members predict that interest rates will rise this year, remain stable in 2023, and then fall slightly in 2024. According to the market, the Fed may be forced to lower interest rates as soon as March 2023.
What does 41-year high US inflation mean for the economy?
According to CME’s Fed Fund Futures Watch, traders expect the first 25 basis point interest rate cut to occur in March, followed by a second cut in July 2023. When the economy enters a recession, “the market appears to believe that the Fed will act as it did in the previous three recessions by promptly easing,” Ackman said.
The recovery of the US stock market overnight after losses of more than 2%, as well as the vigour of Asian markets today, reflect market expectations that the Fed will unleash its money policy bazooka far sooner than the central bank would prefer.
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According to CME’s Fed Fund Futures Watch, traders expect the first 25 basis point interest rate cut to occur in March, followed by a second cut in July 2023. When the economy enters a recession, “the market appears to believe that the Fed will act as it did in the previous three recessions by promptly easing,” Ackman said.
The recovery of the US stock market overnight after losses of more than 2%, as well as the vigour of Asian markets today, reflect market expectations that the Fed will unleash its money policy bazooka far sooner than the central bank would prefer.
According to Vivek Kumar, an economist at Quantico, “this could once again prompt strong money policy reaction from the Federal Reserve, enhancing the chance of another 75 bps rate rise in their scheduled policy review later this month.”
In response to persistent inflation, Fed policymakers have already hinted at a second 75-bp increase in interest rates this month. To control inflation, Fed officials raised interest rates at the fastest rate increases since the late 1980s. To combat rising inflation, the Federal Reserve of the United States raised interest rates by 75 basis points, or 0.75 percentage points, in June, the largest increase in 28 years.
Last month, Fed Chair Jeremy Powell stated unequivocally that the institution would refrain from raising interest rates until it had “compelling evidence” that inflation was slowing.
Numerous experts have also stated that the Federal Open Market Committee (FOMC), which will meet on July 27, should raise interest rates as a result of rising inflation in the United States. The FOMC, a Federal Reserve committee, sets interest rates in the United States. Analysts predict that the FOMC will raise the US central bank by at least 75 basis points at its meeting later this month.
The US Federal Reserve’s aggressive monetary policy will continue to put pressure on emerging economies via capital outflows and exchange rates.
This could have three effects on India. First, as the interest rate differential between India and the US narrows, India loses some of its allure as a location for currency carry trade.
A churn in developing market equities due to higher returns in US bond markets may dampen international investors’ enthusiasm for investing in India. Third, withdrawals from the Indian equity and debt markets may have an impact on currency markets.
According to new data from the US Department of Labor, consumer prices have risen by 7.5 per cent over the previous year.
This country’s inflation rate is the highest in 40 years. On the supply side of the equation, rising labour costs, scarcity of goods and services, and supply chain issues have all contributed to inflation.
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Strong demand was fueled by the US Federal Reserve’s fiscal stimulus program, US government assistance, low borrowing costs, and the country’s quick economic recovery. Inflation in the United States has been caused by a supply-pull imbalance between supply and demand.
For the majority of the previous year, the US Federal Reserve maintained an accommodating stance. Still, it has recently been suggested through hawkish pronouncements on interest rate hikes to contain inflation in the country.
However, the record-high US inflation does pose a risk for India, even if 7.5 per cent inflation may not appear severe to many Indians who recall CPI inflation reaching as high as 12.31 per cent in the immediate aftermath of the 2008-2009 economic crisis.
When purchased by India, the prices of these commodities will rise in tandem with the cost of goods in the United States.
The rise in global inflation has a major impact on commodities such as edible oils, beans, and fuel.
