There has been much skepticism about
the Fed rate hike and the fate of financial markets , especially the emerging
markets. There is general belief that higher Fed rate will be bad for the markets.
This may be true in theory as the assumption is, the carry trade is likely to be affected, with investors reverting back to the safe
haven of US treasuries. However, evidence proves that in
the last fifteen years Dow has found a positive correlation to the Fed rate as seen from the following
chart of Dow and Fed interest rate.
During the period 2001-03 and 2007-09 Dow declined in tandem
with the lowering of Fed rate. While it
moved up during 2003-07 when rates were increased by Fed.
While the DOW has performed well during the period Fed rate
was at 0% from 2009 till date as Fed unleashed three
rounds of QE , which bolstered the US economy
and put it on path to recovery. After
all, the Fed hikes rates when it is confident the growing economy is able to
withstand the increased borrowing costs.
A strong US economy would have positive connotations for the
emerging markets and any outflow from
the emerging markets are likely to be minimal or may reverse in due course. This is particularly true for India, a strong consumption story and riding
the wave of low commodity prices. However the same cannot be said about Russia and Brazil, the net commodity
exporters bearing the brunt of the low commodity
cycle. With China still struggling to
maintain its growth rate and most of its infra projects completed, demand
pickup is a worry.
India may find itself in a sweet spot with improved business
environment and kick-off of infrastructure projects, any incremental flows post
Fed hike are likely to find their way here. The GDP rate differential , 7.5% -8%
for India as compared to 2.1% for the US makes the Indian market highly
attractive for the investors.
With Fed increasing the
rates from 0.25% to 0.5% , reversing its
rate policy for the first time since 2006 indications are there that the future rate
hikes are likely to be measured and gradual.
With the overhang of
Fed hike over, markets may chart their course for 2016 on a better note.
