Inevitable inching closer: US Fed may raise rates after 3 years. What it means for Indian stock market

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Morgan Stanley has also joined a growing number of major Wall Street banks taking a more hawkish view on global interest rates. The brokerage is forecasting additional monetary tightening by both the US Federal Reserve and the European Central Bank as inflationary pressures remain persistent, Reuters reported.
According to Reuters, Morgan Stanley expects the Fed to deliver another quarter-point increase in December. The forecast follows recent US inflation data that came in stronger than expected.
Morgan Stanley's revised outlook reflects concerns that the decline in inflation has not been strong or consistent enough to give policymakers confidence that price pressures are moving sustainably towards the Fed's target.
The brokerage now expects two Fed rate hikes this year and sees the central bank signalling the possibility of further tightening before eventually pausing as inflationary pressures ease.
The shift in market expectations has been striking. Barely two weeks ago, the CME FedWatch tool showed a 60% chance of a rate cut. Traders are now pricing in a 92.5% chance of a Fed rate increase. If delivered, this will be the first rate hike in over three years.
What would it mean for Indian investors?
For India, the stakes are significant. US Treasury yields above 5% would make an emerging market such as India even less attractive to foreign institutional investors (FIIs), which have already dumped more than Rs 14,400 crore of stocks over the past two weeks. FIIs continued to sell even after India attracted record subscriptions to special forex-inflow programmes, which came with regulatory hedging latitude, aimed at boosting reserves and supporting a wobbling currency.
“In today’s meeting, the Fed is most likely to raise interest rates by 25 bp. However, this is unlikely to impact the market since it is already discounted by the market. More market-moving will be the Fed commentary on the evolving macro outlook and the likely rate action going forward,” V K Vijayakumar, Chief Investment Strategist at Geojit Investments, said.
A Fed rate hike could strengthen the dollar, pressure the rupee, lift bond yields, and trigger near-term volatility in Indian equities. However, some of this is already priced into markets, making the Fed’s forward guidance just as critical as the decision itself. Investors will closely assess whether the move is a one-off response to inflationary pressures or signals the beginning of a more sustained tightening cycle.
Sunny Trisal, portfolio manager at Investvalue Capital, said a sustained rise in global yields and oil prices could further complicate the domestic monetary policy outlook. Within equities, exporters could benefit from a weaker currency, while importers and companies with significant foreign-currency borrowings could face headwinds.
For gold, the impact is likely to be mixed. Higher US interest rates increase the opportunity cost of holding a non-yielding asset, which typically weighs on global gold prices. However, rupee depreciation could partly offset this decline for Indian investors. Geopolitical uncertainty and continued demand for safe-haven assets could also lend support to gold.
For debt investors, higher yields could trigger short-term mark-to-market volatility, particularly in longer-duration bonds. At the same time, a repricing of yields could create better entry points in high-quality short- to medium-duration debt for investors with an appropriate investment horizon. The trajectory of US yields, crude oil prices, inflation and the RBI’s policy response will remain key factors for Indian fixed-income markets.
The risks of an equity devaluation, particularly in developed markets like India, are therefore real unless earnings pick up sufficiently to justify the equity risk premium. Higher bond yields could also gradually reduce equity allocations by conservative institutions such as large pension funds, which operate with low but steady return mandates. If unusually high risk-free rates are sufficient to meet their return requirements, these investors have less need for exposure to riskier equities, adding further pressure on stocks.
Such a backdrop could ultimately test the resilience of domestic retail investors, who now own about a fifth of Indian equities directly or indirectly and have provided a bulwark against recent bouts of FII selling.
Disclaimer: This article has been written by Veer Sharma, who is not a SEBI-registered Research Analyst or an Investment Adviser. Veer Sharma and his/her ‘relative(s)’ (as defined under Section 2(77) of the Companies Act, 2013) do not hold any financial interest in the companies mentioned in this article as of the date of publication. The views/recommendations mentioned in this article, wherever applicable, are those of the respective SEBI-registered Research Analyst/brokerage and have been reproduced/reported with due attribution. They should not be construed as the views or recommendations of The Economic Times Digital or the journalist. Readers are advised to consider the original research report and make their investment decisions based on their own assessment. Brokerage disclaimers here.
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