Fed Rate Cut: Does it Matter for India?

The much-awaited moment finally became a reality. The Fed, at last, announced a 50 basis point cut in its policy rate on September 18—the first since 2020—which is momentous for two reasons: one, it marks the beginning of a monetary-easing cycle. Two, it represents the Fed’s belief that inflation is no longer a problem but what matters now is giving a nudge to employment.

The Fed’s rate cut, as anticipated, triggered volatility across asset classes. After the announcement, the United States equities ended lower—S&P 500 ended down 0.3% after rising 1% during the session—which is a historical feature. Some analysts believe that the market has already priced in the rate cut— hence the initial fall in the index. That aside, the spot gold too ended lower in the international market—after touching an all-time high of $2,618 per ounce on September 18, it was quoted at $2,587 on the next day. This is, of course, likely to be a short-lived feature, for a weakening dollar is always found to be advantageous for gold prices to go up.  

But Asian equities recorded meaningful gains. On balance, it is perceived as a positive development for developing economies. Coming to the Indian stock market, its impact may not be that significant, for it has already been attracting investor interest for the last several years, said Chief Economic Adviser Anantha Nageswaran.

Nevertheless, two days after Fed’s rate cut announcement, the BSE Sensex, soaring to an all-time high of 84,694.46, settled at 84,544.31—a rise of 1.63%. Similarly, the NSE Nifty 50, rising by 1.48%, settled at 25,790.95. Although the global macroeconomic factors are currently favoring equity markets, analysts opine that volatility is likely to continue in the equity markets owing to the uncertainty about the upcoming US elections, the ongoing economic slowdown in the US, and other geopolitical factors. 

The rate cut is expected to result in a global rally in debt markets that would likely improve liquidity in the market which in turn can make finance cheaper for businesses. Analysts also opine that the rate cut may also weaken the dollar making US bonds attractive for foreigners. Though the Fed is assuring investors that the US economy is in good shape by calling the move a ‘recalibration’ to stay ahead of any potential weakening in the job market, analysts, fearing that the 50 bps cut is just the beginning of Fed’s fight against likely recession, expect demand for oil to remain stagnant in the Western world and this may keep oil prices slightly tilting southwards. However, the impact of China’s stimulation and the Middle East conflict may as well challenge this assumption. 

Fed officials have given a feeling that another 50-bps policy rate cut is likely to happen this year followed by a 1 percentage-point cut in 2025. However, in his post-policy interaction with the media, Fed Chairman Jerome Powell stated that this cut should not be interpreted as the new pace. It is also to keep in mind that though the inflation is currently around 2.5%, which is very nearer to the Fed’s medium-term target of 2%, one cannot expect a large reduction in the policy rates for it may lead to the risk of inflation turning sticky—which the Fed obviously won’t like. All this leaves the market with a caution: projections being projections, one has to wait and see how the Federal Open Market Committee moves forward. 

Intriguingly, the current rate cut comes despite most economic indicators of the US looking fairly solid. In such a scenario, lowering interest rates could increase consumer spending relatively quickly. Over it, Powell described the rate cut as a calibrated move to take the policy rate to the neutral rate—a policy rate that is neither restrictive nor accommodative. And, the committee expects the long-run neutral rate to be around 2.9%, while analysts place it around 3.5%, for the US budget deficit has increased considerably. So, this phenomenon may impose limitations on the scope for steep rate reduction.  

So, to that extent the current easing cycle being different, global capital flows are likely to remain constrained. Of course, India had so far managed the Fed’s tightening storm rather effectively. Now that its easing cycle is underway, it may have to manage the resulting fluctuations in capital flows in such a way that it would not cause any upward pressure on the rupee, for it could affect Indian exports. In the same vein, the Reserve Bank of India may have to stay focused on maintaining the inflation rate well within the target of 4% sustainably.

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