Is the G3 done with rate hikes?

Like the G3 central banks, the RBI MPC is likely to opt for a prolonged hold

Radhika Piplani

Chief Economist

DAM Capital Advisors

Mumbai, November 3, 2023:  After a series of significant global central bank meetings this week, we provide you with a concise yet insightful overview of the G3 interest rate outlook, our perspective on currency and bond yields, and potential implications for India.

Is the US Fed done with its rate hike cycle?

• In our view, yes. There is less urgency for a rate hike by US Fed as financial market conditions tighten, evidenced by the recent rise in long-term yields, which act as a substitute for rate hikes.
• However, the Fed will continue to remain data dependant and keep assessing the tightness in financial market conditions. It chose to overlook the recent uptick in inflation readings and the strong labour market data. Instead, the Fed Chair Powell emphasized the progress in reducing inflationary pressures and cooling labour market.

Is inflation or higher oil prices no longer a concern for the Fed?

•  From our perspective, it is still a concern. Consumer confidence moderated in October with higher prices, especially gasoline prices seen as one of the key reasons. However, Powell seems comfortable with the current downward trajectory of inflation.

Did the September dot plot suggest a possibility of another rate hike this year? 

• Yes, it did. However, it is unlikely to happen. In the post policy conference, Powell suggested that the recent increase in long-term bond yields signal an implicit tightening of financial conditions. Market participants estimate that the tightening is equivalent to 25-50 basis points of rate hike.

The BoE also left interest rates unchanged today. Does that mean G3 central banks (ECB, BoE, Fed) have all entered a phase of long pause?

• We believe so. The BoE left interest rate unchanged (6-3 vote split) but continued to maintain a hawkish undertone. The G3 central banks have been unanimous in signalling a ‘higher for longer’ policy, pushing back on market expectations of a rate cut cycle commencing any time soon. We do not see interest rate cuts before H2 CY24. As per a Bloomberg survey (Exhibit 1), ECB is expected to be the first among G3 central banks to begin cutting rates next year.

What are the implications for currency and yields?

• After the Fed’s relatively dovish tilt, the FX market’s reaction was risk-on trade. The Dollar Index moderated from 107+ level to 106 following the policy announcement. However, we are bullish on dollar’s near-term trajectory for two reasons: (1) uncertainty around geopolitical developments likely to result in safe-haven dollar demand and (2) better macro environment in the US relative to other developed economies.
• The 10Y US treasury yield moved sharply lower towards 4.6%, triggered by the announcement of lower-than-expected auction size of long-term government debt (in particular, 10Y and 30Y securities) and the Fed policy announcement. The fall was also triggered by weak ISM manufacturing for October. Despite this, we believe that long-term yields can rise again towards 5% due to the high quantum of bond sales and any upside surprise on inflation.    

What are the implications for India?

• Like the G3 central banks, the RBI MPC is likely to opt for a prolonged hold. Further repo rate hikes are off the table, with the transmission of a cumulative 250 bps hike still underway. There remains a readiness to act if the situation warrants, to tame inflation by anchoring inflation expectations.  We expect no change in repo rate through H1 FY25. A rate cut is likely in H2 FY25 once inflation is sustainably close to RBI’s 4% target range and monetary policy starts to ease globally. Meanwhile, managing liquidity conditions through OMO sales will be the preferred tool.  Amid the prevalence of tight banking sector liquidity, bond yields may continue to remain elevated. We expect 10Y g-sec yields to trade in the range of 7.25-7.40% in the near term.
• We expect USDINR to trade in the range of 83.00-83.50 in the near term, however, it is likely to touch a level close to 84.50-85.00 by March 2024, on account of continued pressure from higher oil prices, dollar appreciation, along with some normalisation in capital flows.

(Disclaimer/Disclosures: DAM Capital the Research Entity (RE) is also engaged in the business of Investment Banking and Stock Broking and is registered with SEBI for the same. DAM Capital and associates may from time to time solicit from or perform investment banking or other services for companies covered in its research report. Hence, the recipient of this report shall be aware that DAM Capital may have a conflict of interest that may affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. The RE and/or its associate and/or the Research Analyst(s) may have financial interest or any other material conflict of interest in the company(ies)/ entities covered in this report.)