Fed Has Cut Rate, But RBI Is In No Hurry To Follow Suit

The US Federal Reserve unanimously cut its policy rate by 25bps recently, as was widely expected, pulling fed funds rate down to 4.5-4.75 per cent. In the post-meeting press conference, its Chair Jerome Powell cited recent upward revisions to GDP accounting, still-strong consumption, and a solid labour market as evidence of growth resilience, while attributing much of the current rate of inflation to lagged pressures like shelter and insurance. That said, Powell emphasized that the ‘job is not done on inflation’. He seemingly sought to keep the committee’s options open for December, reiterating the Fed’s data-dependent stance rather than providing any concrete forward guidance. Although the cut led to a relief rally in bonds, the US dollar weakened. In response to questions around Donald Trump’s victory, Powell stressed that the election will have no near-term effects on policy decisions. He avoided getting into election-related risks to the outlook. But he did make it clear that he would not resign if asked to put in his papers.

Notably, he also indicated that firing or demoting a chair (or any vice chair) is ‘not permitted under the law’. While December may still see a 25bps cut, the risks are clearly skewed towards a delay or even a slower pace, given the backdrop of still-elevated inflation. We note the Fed funds futures pricing has now materially moved post the election outcome to merely 2.5 cuts in CY25. Early this year, analysts had feared the risk of the Fed over delivering, but they had maintained that the cut cycle would be shallower than the past ones. The rising term premium, Emkay hopes, is likely to be the next driver of higher yields, led by greater macro volatility, persistent inflation plus large fiscal deficits, and higher debt issuances. This will keep a trough on yields amid much higher than expected terminal Fed funds rate and higher term premia.

Besides, the surge of US debt could see fewer buyers ahead. With deficit sustainability remaining an issue, the price of fiscal money is likely to stay elevated). This is likely to spillover to the rest of the world as well, with relatively higher term and risk premia in EMs. Early this year, we had called out for no cuts by either the Fed or the Reserve Bank of India (RBI) in CY24. While the Fed hastily cut more than required, a December rate cut call remains tricky for RBI and may lead to a shallower rate-cut cycle, following the Fed next year. Thus, mild G-Sec bear flattening may make a comeback. Of course, the implications of higher US term premia may lead to higher global rates in medium term. However, India's current favourable DD-SS structure of sovereign papers may keep it relatively better placed than other EMs, though not directionally. Nevertheless, the spillover of bond/FX volatility via the global financial markets route could also mean the aim of financial stability may even precede inflation management for RBI, at least in some cases.