Federal Reserve signals hike in interest rates

Federal Reserve signals hike in interest rates

Subject : Economics

Context : Recently, the Dow Jones Industrial index in the US fell 0.77% and treasury yields rose after the Federal Reserve indicated that there could be two rate hikes by 2023.

Concept :

• In India, the benchmark Sensex fell marginally and the rupee lost over 1% against the dollar after indication from Federal Reserve.
• The wholesale price index-based (WPI) inflation have scaled a record high of 12.94% in recent month which was pushed by higher fuel and commodity prices and a low base effect.
• It also translated into retail inflation of 6.30% which led to breach of the inflation target of 4 ± 2% set by the Reserve Bank of India.

Key Highlights of signals from Federal Reserve

• They said that they would continue with an accommodative monetary policy and bond buying programme to support the economy, generate employment and achieve inflation of around 2%.
• It discussed the rate hike and an eventual reduction, or tapering, of the central bank’s bond buying programme.
• The Fed had signalled that there could be at least two rate hikes by 2023 as economic activity indicators have strengthened and inflation has firmed up.

Impact of an early hike in interest rates

• The indication of a hike in interest rates earlier than expected resulted in a rise in bond yields and strengthening of the dollar.
• It impacts currencies and stock markets in emerging economies such as in India, benchmark Sensex fell 461 points or 0.87% during the day.
• It would lead to an outflow of funds from equities into US treasury bonds and outflow of funds from emerging economies to the US.
• The experts believe that a rise in yields leads to a situation where they start competing with equities, and market movement is severely impacted.
• The rupee is also expected to come under pressure as the dollar strengthens.