The US Federal Reserve (FED) expectedly hiked policy rates by 75 bps (100 bps = 1.0%) to 3.75%-4% target range at the FOMC meeting in November 2022 and quoted the need for ongoing hikes until rates became “sufficiently restrictive”. Furthermore, the FED indicated an ultimate rate level higher than previously expected, but with slower than current pace of rate increases.
The ECB raised its policy rates by 75 bps and indicated further rate hikes at many more meetings. The ECB’s decision to revise the terms on its targeted long term refinancing operations surprised the markets.
Global market’s hopes for a FED “pause/pivot” were dashed by Governor Powell and markets were woken to the need to come to terms with a higher-for-longer policy rate regime. With US policy rates expected to peak around 5%, emerging markets may need to maintain a significant interest rate differential. We expect a high likelihood of RBI raising the policy repo rate by 35-50 bps in December 2022 and see upward risks to our peak India repo rate expectation of 6.25% - 6.50%.
Though global institutions voiced concerns over the pace of US policy rate tightening, and this had raised hopes of a dovish FED hike, we further reduced duration and increased cash holdings across our portfolio in October 2022; on the back of RBI’s September 2022 Monetary Policy (MPC) meeting and the OPEC+ oil production cut.
We expect the markets to provide good investment opportunities to deploy our cash over the medium term. The increase in the credit deposit ratio of the banking system has led to higher short term interest rates and supply of tradable bank issuances and this has made the shorter end attractive for a risk/reward perspective. We will continue to look at tactical investment opportunities across benchmark sovereign bonds.