New Delhi: Uncertainty has gripped the financial markets in the USA, the world’s biggest economy, over the past week. The situation is likely to remain the same in the coming week as well, since the US Federal Reserve, that sets the benchmark policy rates in the country, gears up for the crucial monetary policy meeting scheduled later this month.
All major central banks, including the Reserve Bank of India, will be closely watching the next move by the US Fed Reserve this month as any action taken by the Central Bank of the world’s largest economy immediately impacts countries in Europe and Asia. US Fed Chair Powell's semi-annual monetary policy testimony reflected a positive view of the current economy and renewed concern about the path of inflation. Powell’s testimony caused traders to ramp up rate hike expectations, largely pricing in a 50 basis point (0.5%) hike at this month's meeting.
However, things are not easy for any central bank these days as they need to strike a balance between fighting high inflation and supporting economic growth. In India, the Reserve Bank is also grappling with the same problem over the last one and a half years as it started to hike policy rates in May last year to cool down the retail inflation as mandated by the law.
After Powell’s statement that the fight against inflation was far from over it became clear that the global battle against inflation will last longer than what was previously anticipated by several central banks, including the US Federal Reserve, European Central Bank, and the Reserve Bank of India, among others.
But the US Job data announced last week certainly made the outlook for a rate hike and the quantum of the rate hike in the USA much more clouded after jobless claims data and mixed nonfarm payrolls data disappointed the markets.
Collapse of Silicon Valley Bank
Things became even more complicated with the liquidation of Silvergate Capital and the collapse of Silicon Valley Bank in the USA which was funding a large number of US technology startups.
It raised questions about the broader stability of regional banks in the face of the most aggressive pace of US Fed rate hikes in the last four decades as the Fed raised policy rates from near zero to close to 5 percent in less than a year.
The lack of clarity is likely to make it difficult for the FOMC to increase rates as aggressively as 50 basis points this month which was factored in by several market players.
According to a survey conducted by Oxford Economics, financial markets in the USA are pricing in a roughly 35% probability of a 50 bps hike now, down from close to 75% earlier in the week. The survey also indicated a clear change in the US financial markets expectation about a terminal policy rate to be adopted by the US Fed Reserve this year.
It showed that the terminal policy rate, the rate at which the US Fed is likely to pause further hikes, has also fallen back below 5.30% by the June and July FOMC meetings and below 5.20% by the September meeting after having reached 5.70% for the September meeting earlier this week.
The survey suggested that US financial markets are now also pricing in around 35 bps in rate cuts for the second half of this year which may make it easier for central banks of emerging economies such as the RBI in India to either pause or reduce benchmark policy rates to shore up sagging growth.
Crucial inflation data to be released Tuesday
However, that could all potentially change again if Tuesday's CPI release and Wednesday's retail sales figures in the US offer significant upside surprises.
