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Thursday, December 15, 2016

Fed Rate Hike and Impact on Emerging Markets

 
Fed Rate Hike Impact



The Federal Open Market Committee (FOMC) determines the monetary policy in the US. The US Federal Reserve's meet is keenly followed globally by policy makers and investors alike.

Here is how a rate hike will impact emerging markets (EMs) like India:

1. Why is the Fed meet such an important event for markets?

The Fed's actions have the potential to stir world markets. With the US being the world's big gest economy and the dollar being the world's reserve currency , any action by the country's central bank to influ ence the money supply has repercussions on the global financial mar kets.

2. How does Fed's decision have an impact on EMs?

The US has been a major source of capital for emerging markets. The link has strengthened all the more since 2008-09 when the Fed launched its monetary stimulus known as quantitative easing (QE) and cut rates to near-zero. Thanks to a series of QEs since then, emerging markets have received billions of dollars.The monetary stimulus has been withdrawn and now the Fed is in the process of raising rates. This has sparked worries that a portion of the dollars invested because of the easy monetary policy will now flow back to the US. A rate hike would mean a stronger US dollar. This is a critical impact of a rate hike in the US. Higher US interest rates tend to depress the values of emerging market currencies against the dollar.This comes at a time when many EM economies are already weakening and their currencies have already slumped against the greenback. The Fed's rate hike has the potential to start a currency drag.

3. Why should it affect foreign capital flows into EMs?

If the Fed raises rates, it could result in money flowing back to the US, resulting in strengthening of the dollar. A stronger dollar is likely to deter FIIs from making fresh investments. So, in theory , a series of rate increases by the US Fed is not good news for EMs like India.

4. What is the probability of a rate hike this time around?

Market participants seem to have factored in a 25 basis point rate hike when the Fed meets on December 13 and 14. It is expected that the central bank will increase rates.However, what market players will watch more closely would be the commentary that the body provides and any indications of its stance on the rate hike trajectory going forward.







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