By:- Nachiketa Sawrikar, Fund Manager, Artha Bharat Global Multiplier Fund
The Federal Reserve's decision to raise interest rates by 25 basis points was largely anticipated by financial markets. With inflation well above the Fed's 2% target, economic growth resilient and the labor market relatively stable, we believe the Fed needed to demonstrate its commitment to restoring price stability.
It also felt like financial markets forced the Fed's hand. This is in contrast to the controversial December rate cut, when Fed officials prepared markets for a cut despite persistent inflation. Today's unanimous decision effectively reverses that December move.
The more important question for financial markets is what happens to longer-term interest rates. The 10-year Treasury yield has risen approximately 100 basis points from its February lows, including about 50 basis points since July. Some increase was understandable given higher inflation. However, in our view, much of the more recent increase could have been avoided had the Fed raised short-term rates in June or July.
As we have argued previously, sometimes raising short-term interest rates is precisely what is needed to bring long-term interest rates down. A credible commitment from the Federal Reserve to control inflation should help stabilize, and potentially lower, longer-term Treasury yields.
Today's projections reinforce the Fed's inflation-fighting message. Sixteen of the 18 participants expect at least one additional rate increase this year, suggesting today's move is not necessarily a one-time adjustment.
For equity markets, stabilization in longer-term rates would be constructive and allow attention to shift increasingly toward corporate fundamentals and the upcoming third-quarter earnings season.
