Federal Reserve's (Fed) monetary policy affects capital markets across the globe to a vast extent. Rising interest rates in the U.S. are often linked to outflows from emerging markets. Until recently, it was believed that the Fed would gradually increase the target range for the federal fund's rate if the job market improves further and inflation inches closer to its 2% target. There has been a consensus among market experts, economists and bankers across the globe about Fed hiking interest rates in the Federal Open Market Committee meeting in December 2016.

As per the labour statistics published on November 4, 2016, the unemployment rate dropped to 4.9% in October as the world's largest economy added 1.61 lakh non-farm payroll jobs.

Further, the retail inflation in October came in at 1.6% while the core inflation (retail inflation excluding food and energy items) stood at 2.1% in October on a year-on-year basis. This suggests that if oil prices go up for any unforeseen reasons, the overall inflation may rise above current levels.

 

Fed's outlook on monetary policy stance in pre-election times... "In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal."

Mr Donald Trump's unexpected victory seems to have now divided experts and economists in two teams. The Dollar Index recently climbed to a 13-year high displaying anxiety among investors.

The jury is still out on Donald Trump's policies…

One camp believes, Mr Donald Trump may actually go ahead with his plans, impose immigration and trade policies he promised during election campaigns. If it happens, growth will take a hit in the near term. Such policies would also change Fed's economic outlook, and in effect, it's monetary policy stance.

However, the other side feels Mr Trump might invest heavily in infrastructure and defence as he has promised. Moreover, he has also reiterated his support to lowering tax rates for all. These policies would boost growth but may cause inflation to move up faster than anticipated. Nevertheless, lower taxes may result in higher deficits, at least initially. All these factors might make Fed take a more hawkish stance and increase interest rates faster.

Now if you have concluded that Fed might have to consider aggressive rate hikes if macroeconomic conditions change quickly, then wait a minute. Take time to read what Fed chairwoman, Janet Yellen, had to say while addressing the Joint Economic Committee of Congress, for the first time since election results came to hand. She said, "We don't know what's going to happen." Her comments highlight the uncertainty that revolves around the policy guidance of the Government. She also added that "We will be watching the decisions that Congress makes and updating our economic outlook as the policy outlook becomes clearer."

Nonetheless, she's given enough hints about the short-term policy approach of the Fed when she said, (a rate hike) "could well become appropriate relatively soon."

What to expect?

The Fed is likely to hike interest rates by 25 bps in December and would continuously review the economic conditions to assess the scope for further hikes. Having said that, over a slightly longer term, it would evaluate the policy of the new Government and construct its view.

Will Indian markets be affected in any way?

It appears that a rate hike of 25 bps by Fed has already been factored in by the capital markets. However, any steeper hike may discourage global investors to look at emerging markets, as U.S. Treasuries may become suddenly attractive. In such a case, emerging markets, including India, might see capital outflows.

Falling bond yields and higher valuation in equities may make India more vulnerable to capital outflows. Domestic factors such as demonetisation and possible fall in the corporate earnings to name a few would make Indian markets more unattractive to global investors.

What investors should do?

PersonalFN is of the view that you should avoid speculating on the market and invest at regular intervals. For doing so, you may prefer, Systematic Investment Plans (SIPs) offered by mutual funds. Your asset allocation should be in line with your financial goals and risk appetite. This will be determine your success in investing.

 

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