US Central Bank Hikes Interest Rates! How Will it Impact Investors?

Key Points

• The US Central Bank raised its benchmark interest rates by 0.25% to a targeted range between 4.50%-4.75%.
• The benchmark interest rate is now at the highest since 2007!
• The Central Bank believes that the fight against inflation is not over yet, indicating that the rate hikes will not be halted in the near future.
• The Central Bank noted that any future interest rate hike will be 0.25%.
• The Central Bank reaffirmed its inflation target of 2%, which currently stands at 6.5%.

US Interest Rates: Interest rates hiked, but at slower pace

The US Central Bank raised its benchmark interest rate by 0.25% to a targeted range between 4.5%-4.75%. This is the highest level since 2007.

Although it is slower than the series of 0.75% and 0.5% hikes in recent times, the Central Bank’s hawkish tone suggests that the fight against inflation is not yet over.

US Interest Rates: Link between inflation and interest rates

The Fed’s decision to reduce the size of its latest rate hike follows last month’s economic data showing US inflation easing to 6.5% in the year to December 2022, down from 7.1% recorded a month earlier. Even as inflation has cooled, it is still quite higher than the 2% inflation rate targeted by the US central bank. 

The world continues to struggle with inflationary pressures brought on by a harmful concoction of economic forces. These include escalating energy costs, which are made worse by the conflict in Ukraine, as well as a number of supply chain constraints brought on by the Covid-19 outbreak.

To tame this inflation, central banks hike interest rates. But continuous interest rate hikes can lead to recessionary concerns. 

Recession is essentially a drop in demand for basic goods and services which in turn leads to slower economic growth. When interest rates are higher it takes money out from people’s hands as they have to pay more to borrow for businesses, housing loans. 

US Interest Rates: Sector Most Affected

Technology stocks:

Technology shares are most sensitive to interest rate changes. Investors generally look at these stocks for their potential of higher future returns or in investment terminology: growth stocks. 

Whenever interest rates jump, it dampens the future earning capacity of these companies and hence are less attractive to investors. Normally technology stocks do not perform well in a high interest rates setting.

The Nasdaq 100, an index which contains the top technology stocks in the US generally drops whenever the US central bank raises interest rates. The index has dropped about 25% since January 2022 due to continuous rate hikes by the US central bank.

How will the Fed's rate hike impact the Indian economy?

Weaker Rupee: With increasing interest rates in the US, the Indian market will become less attractive to foreign investors. A rising trade deficit, owing to growth in imports outpacing exports, and several other factors have already caused the Indian rupee to weaken. The latest rate hike by the US Fed will improve yields on US treasuries and reinforce the Dollar’s strength against the rupee.

Worsening inflation in India: India’s inflation rate may accelerate as a result of the Fed rate hike. Depreciation of the rupee will increase the rupee cost of imported goods such as chemicals and fertilizers, electronics, crude oil, and active pharmaceutical ingredients.

This is not investment advice. Investments in the securities market are subject to market risk, read all the related documents carefully before investing. Past performance is not indicative of future returns.