The FOMC (The Federal Open Market Committee) listened to what the market said and raised Fed Fund rates by a huge 75 basis points last night. This is the biggest increase since 1994, and it was done because of how high prices were in May.
At the FOMC meetings in July and September, there could be another 50–75 bp hike.
The Fed has also changed the dot plot chart to show that the median Fed Fund rate will be around 3.4% by December 2022, up from 1.8% in March 2022, and 3.8% by December 2023, up from 2.75 in March 2022. The new forecast is in line with what the market thinks Fed Fund rates will be.
The Fed appears to have regained its “hawkish-on-inflation” reputation with this raise. However, the US headline CPI is expected to remain over 8% y/y for a few more months before beginning to decline. This should keep the Fed on its toes if inflation expectations are revised again.
The Fed will keep tightening aggressively for the rest of 2022, even though the US economy will grow less quickly. This could make it hard for the Fed to meet its soft-landing goals.
Will this move give other central banks the confidence to use a ‘bazooka’ to stop inflation from getting out of hand? It will be interesting to see what happens, and it could be a possibility for some central banks where market participants have already thought about the path to normalisation in the near future.
The yields on USTs have gone down because the FOMC raised rates today. It could be a kind of relief rally because people on the market have gotten rid of the risk premiums they had on the FOMC move. Right after the FOMC made its decision, the Dollar index also went down.
What does this mean for the returns on Indian bonds or India Debt Funds?
The FOMC’s decision about rates today is unlikely to change RBI’s thinking in the near future. But, if the FOMC raises rates by another 75 basis points at its July meeting, the chances of a 50 basis point increase at the August MPC meeting will go up, in our opinion. The recent rise in 364-day T-Bill cut-off yields to 6.28 percent probably shows that the market expects the Terminal Repo Rate to go above 6 percent in the next 12 to 15 months.
We think that the yield on the 10-year benchmark bond should stay within a range and stay below 7.62 percent, which is a technically important level. The yields on long-term bonds are fairly priced and closer to their peaks because there are fewer trades going on and there aren’t enough reasons to sell at the moment.
Since the price of a 10-year bond is close to its 200-month moving average, the risk-reward ratio could be in the favour of investors who are patient.
Conclusion
Investors who want to put new money into fixed-income assets should think about Target Maturity bond ETFs or bond index funds that mature in 2026 or later, depending on how long they plan to invest for. At the moment, the yield curve for Target Maturity bond ETFs and bond index funds is above 7% from 2025 onwards.
A sharp rise in the price of crude oil and food in FY23 could change our view.
Donald G. is the Principal Consultant at NRI Money+. He specialises in creating personalised financial plans for NRIs (Non-Resident Indians) and HNI (High Net-worth Individuals).
