US rate hike: no surprises

The rate hike of 0.25 percent by the US Federal Reserve is a non-event with no surprise element at all. The hike was well-anticipated and its impact has already been priced in by global financial and commodity markets. The strengthening of US Dollar and divergence of investments to dollar-denomination has been happening for a few months and now the Fed has stamped it.
The US cannot afford to let its currency strengthen more as this may hurt its exports while shoving off quantitative easing too fast can jolt the recovery in the US market which is still not fully recovered from the global financial crisis of 2008. Yet the first rate hike in almost a decade is a welcome move and signals the gradual shift from unprecedented monetary and quantitative easing.
The Fed will continue to increase interest rates but at a very slow pace; and the world has already adapted to this new reality. In the last few months, currencies across the board have depreciated against the USD. Gold is on a southward journey too while the slowdown in China and supply gluts have plummeted commodity prices especially oil.
In the past few weeks or so, equity markets around the globe fell due to the anticipated rate hike and mostly rebounded yesterday as the rate hike was not at all surprising.
Pakistan's equity market absorbed the shock of $226 million foreign selling and KSE100 index has fallen by five percent since the start of this fiscal year. KSE, like many other equity markets, was in the green yesterday. The equity market in Pakistan, due to more transparency and market-based flows, is moving in tandem with global and similar economies. The foreign selling continues as on average $4-5 million are flowing out on a daily basis. Market pundits expect the market to fall further amid foreign selling and wait and see is the doctor's orders.
The problem is with country's currency market which is segmented, opaque and too controlled by authorities. In the last eighteen months, the currencies around the world depreciated against USD. In the first round, commodities (especially oil and other commodities indexed to crude) exporting countries currencies fell like nine pins and were followed by the round of other emerging economies as even China's currency fell in August 2015.
One of the most resilient currencies for obscure reasons is PKR which didn't move much. It fell by 2-3 percent following three percent dip in the Chinese currency in August 15. Later, at the start of December, the currency appreciated by two percent and then in the last week or so it has come back to the levels of Rs104.5-105 against USD.
There is some room for depreciation based on REER and it is utmost needed to halt falling exports. However, the economic thinking at the Finance Ministry is different and is arguably adopting a sub-optimal policy which has been discussed in detail in previous columns.
The US Fed rate hike is no exception to change the thinking and behaviour of financial markets in Pakistan and Rupee-Dollar parity may slowly move down to Rs107-108 per USD by June-end. However, the central bank may keep on intervening and not let this happen. That said, it should be noted that currency depreciation is desirable (to bring currency close to its equilibrium) for sustained economic recovery. One option to counter the correction in currency pricing is tighter monetary policy through higher interest rates in the next fiscal year.