US bonds are believed to be the safest debt instruments in the world. If there is a hike in the interest rate there, that will definitely affect the global markets in proportion. Here, markets mean not only the bond markets, but also include currency, derivative and equity.
What Is FED Rate Hike?
Us Fed plays the similar role in the US, as that of the Reserve Bank of India in India. The US Monetary Policy is determined and decided by a committee called ‘The Federal Open Market Committee’. The committee-meet has so much global importance that, investors, analysts and policy makers, unanimously cross their fingers and wait for the result. That’s the impact of FED rate has on Global Markets.
US, being the world’s biggest economy, Federal Reserve of US and its actions has the capacity to stir the Global Markets. The dollar being the world’s reserve currency, decides the value of other world currencies against its value. FED rate hike /cut has the power to control its value in global markets.
US Fed Rate Hike – means, Federal Bank of US is willing to provide the banks of US with the hiked interest rates, for their lending and borrowing activities. Which, in turn, leads to hiked /increased interest rates on bonds, saving deposits, loans etc.
Due to rise in interest rates in the US, the value of Dollar becomes increased, making it more attractive to the investors, in comparison with others currencies, including Rupee.
FED Rate Hike And Its Effect On Global Markets
Emerging Markets like India needs a continuous flow of funds from the FIIs. Being the major source of funds for the emerging markets, US FED Rate hike will definitely have its impact on the Indian markets too. Due to rate hike in the US there will be less flow of money from US to all the Indian Markets including equity investments
Quantitative Easing (QE)
In order to increase money supply in the economy Governments usually follow a monetary policy called Quantitative Easing. Under this policy Government increases the money supply in the economy with an increase in the money lending by commercial banks and thus making consumers to spend more. In 2008-2009, US launched this monetary stimulus called Quantitative Easing. And the series of QEs continued till the recent past and cut rates to almost near zero. Due to this world markets have received billions of dollars to progress. Its now the time that the FED has withdrawn that monetary stimulus and actively processing the plans of interest rate hike. If this series continues the dollar becomes even stronger than before.
There are chances of fund flow from the global markets back to US, leaving them re-estimate their growth rate.
The interest rates in India right now range from 7 to 8 percent. Inflation rate 5 to 6 Percent. Whereas in US both interest rate and inflation are close to 1 to 1.5 percent. Because of this difference in economic conditions, most of the financial institutions in the US were raising /borrowing money on lower interest rates and investing the same in emerging markets like India for high interest rates and returns.
So a lot of financial institutions raise/borrow money in the US on low interest rates in dollar terms and then invest that money in government bonds of emerging countries such as India in local currency terms to earn higher interest. Even after taking into account the depreciation of the local currency due to higher inflation, the investors still earn more than what they could have earned had they just kept their money in the US bonds.
But, after a series of interest rate hikes, investment in the US is much more attractive and profitable than in emerging markets. There is no risk of inflation. Whereas, emerging markets are more prone to sharp rise in inflation.
WEAKER RUPEE MEANS RISE IN INFLATION
India imports more goods than it exports. Our total imports till now stood around $100 billion annually, which are much more than our imports. Value of rupee against dollar is inversely related to the inflation rate. Crude and oil related products are the main essential goods that India heavily imports. Weaker INR makes all our imports more costly. But, helps exports to gain, if they are able to capitalize.
Spending more on imports, due to a weaker rupee against the dollar means again hike in the inflation rate.
EFFECT ON CAPITAL MARKETS (STOCK AND BOND MARKETS)
The impact on the bond markets is the most evident one. There will be a huge outflow of money from the Indian bond markets to the bond markets of the US. All this may not happen all at once, but will happen slowly over the time.
Primarily the Indian Stock Market performance is related to its GDP growth rate. The impact of outflow of foreign investments in the stock market here may be considered as the secondary factor. The impact may be considered as the cascading effect, which may be evident at par after the outflow happens. So, we can come to the conclusion that the effect is only partial, and is not very instantaneous. Due to this time lag, there are chances of market recovery making the effect null.
The biggest financial Institutions are also known as Global Asset Allocators. They invest trillions of dollars in stocks, bonds, currencies… etc, and across the countries and geographies. Allocation is in proportion to the attractiveness of the asset class and risk factors.
US FED rate hike may not be so huge, but definitely show its effect in the future and will be in proportion to the percentage of the rate hike and the number sequences that may occur in future. Of course, the primary constituent is the GDP outlook itself.