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The US Federal Reserve has indicated speeding up the pace of policy tightening. The key interest rate was left unchanged at its latest meet, but with rising inflationary pressure and an improving US economy, the Fed is considering a monetary policy turnaround.

The latest forecasts signal an interest rate hike in 2023, one year earlier than previously assumed. At least seven members of the Federal Open Market Committee (FOMC) are now looking for the first rate hike next year, up from four in March. While this is not enough to raise the median, which remains at 0.125% for next year, but now 13 members foresee the first hikes in 2023, up from seven in March.

It should be noted that the Fed now expects the US economy to grow 7% this year. As for inflation, the central bank said that the high inflation that the US economy is currently seeing will start to abate.

The fear factor
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The fear factor

Also, the central bank is starting a discussion about scaling back bond purchases. In simple terms, the pandemic-driven liquidity flow, a key driver of global equity market rally, would come to an end sooner than expected.

Global equities markets did not like this, but the fall was moderate. The Dow Jones Industrial Average fell 265 points, or around 1%, on Wednesday. The sentiment rubbed-off on Asian equities as well. Key Indian equity market index, the Nifty, lost about 0.5% or 76 points on Thursday. Fear gauge, the Nifty India volatility index (VIX), ended the day’s session up 2.84%. There was hardly any movement in the CBOE VIX as well.

For now, the market is drawing comfort from the US Fed’s pledge that it would remain transparent about tapering, analysts said. However, sooner rather than later, investors will have to shed their complacency.

“We feel that the direction of monetary policy has changed and the peak of loose policy is behind us now. As for the market’s reaction, we expect these developments to start sinking in slowly. We may see bouts of corrections or volatility as the market realizes that in the next three-six months the Fed would lay out a plan on QE tapering as it wants to avoid any sharp reaction in financial markets," said Sahil Kapoor, head, products and market strategy, DSP Investment Manager.

Money pumped in by global central banks in the form of stimulus has helped equity markets remain buoyant despite the covid-19 pandemic’s impact on economies. “Not even halfway through 2021, investors had poured more money into EM (emerging market) assets than many recent full calendar years. With the change of stance by the Fed last night, we will see outflows soon because the fear of missing out (FOMO) is a form of volatility and fear or greed are subconsciously motivated by FOMO," analysts at Nirmal Bang Institutional Equities said in a report.

With the Fed meeting done, the focus shifts to the Jackson Hole meeting scheduled in August. “A statement in November about a tapering decision in December or January is not very much of an early warning signal for markets that will need it to avoid a taper tantrum, which brings us back to August (Jackson Hole) or September (FOMC meeting, with new projections) as potential dates to flag tapering," analysts at US-based Rabobank said. The Fed’s hint on an early taper does set a tone for global equity markets, but analysts said the Reserve Bank of India (RBI) will not hike rates in a hurry.

That said, there are other downside risks for the Indian stock market. Deepak Jasani, head of retail research at HDFC Securities Ltd, flagged a potential third wave of infections, a weakening fiscal situation, worries over inflation, and weakening asset quality of banks, as some negative triggers. Indian investors may have shrugged off the Fed’s shift, but as dollars begin to shrink, equity markets may see their moment of truth.

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