Two friends watching one of their favourite F.R.I.E.N.D.S episodes got into an interesting conversation.
Ram: Ross shouting in this episode ‘Pivot Pivot Pivot’ reminds of market participants screaming for the Fed Pivot. What exactly does this mean and what do the market participants actually want?
Veena: Pivot means rotate in some parlance. Many investors are just calling for the US Fed pivoting from continuing to increase interest rates to tame inflation. Higher interest rates have been playing havoc in international stock markets, although our markets have turned out to be resilient. Investors are hoping for a pivot by the global central banks and more specifically the Fed, in the expectation that this may finally put an end to the carnage in global stock markets.
Ram: But can the Fed actually pivot?
Veena: Ha! The Fed Governor Jerome Powell buried all those expectations last week. Investors initially associated pivot with cutting interest rates. Then as the Fed kept increasing rates, they associated pivot with a pause in hiking. However now after 4 unprecedented 75 bps hike by the Fed, investors are exhausted and associating a pivot with slowdown in hikes from 75 bps to 50 bps!
Ram: But did not the Fed actually leave open the possibility of slowing down rate hikes to 50 bps, meeting the watered-down definition of pivot?
Veena: In form yes, but not in substance. While leaving open the possibility as you said, Jerome Powell more than offset it by strongly noting that interest rates will increase higher than what the Fed earlier projected, and that it was too premature to think of pause in rate hikes. This spooked global bond and equity markets as their earlier expectation was that a softening of rate hikes was a precursor to an imminent pause.
Ram: Oh ok! But why is the Fed so firm on this?
Veena: They are wary of what happened earlier. During the 1970s, when inflation was high, a pivot by the then Fed President Arthur Burns turned out to be too premature and resulted in a decade-long inflation fight. Powell today will be wary of that. He, in fact, went on to re-iterate in no uncertain terms that if the Fed over-tightened (i.e. increase interest rates too much), they could fix it with their monetary tools. At the same time, if they do not tighten enough, inflation will become more entrenched and the long-term consequences to economy and jobs will be more severe.
Ram: Hmm.. ok. So what does this mean for our markets?
Veena: Historically the US central bank actions have impacted our markets. The higher the interest rates in the US, relatively less attractive is emerging markets investment for FPIs, especially when valuations are expensive and exchange rates can also come under pressure, impacting their overall returns. However, our markets have turned out to be very resilient. How long it remains so in the absence of a pivot, is a wait and watch!