The US Federal Reserve has reduced its benchmark interest rates by a quarter of a percentage point, marking the second consecutive cut this year. The decision, which places the target rate between 3.75% to 4.00%, was driven by concerns over a cooling labor market and elevated economic uncertainty, despite inflation remaining somewhat high. Economic activity continues to expand moderately, but job growth has slowed and unemployment has edged up, although it remains relatively low through August.
The decision-making process for the Federal Open Market Committee (FOMC) was complicated by the ongoing US government shutdown, which restricted the publication of key economic data. Furthermore, the vote was not unanimous, with one member favoring a larger 50 bps cut and another voting for no change in rates.
Commenting on the implications for India, Vishal Goenka, Co-Founder of IndiaBonds.com, stated, “The US Fed cut benchmark overnight rates by 25bps as expected. However, Governor Powell very distinctly highlighted that any further cuts in next December meeting is not a done deal. Their decision-making is further complicated by lack of published economic data due to US government shutdown. This is a clear green lighting for RBI to cut repo rate in its next meeting in early December.”
Goenka argued that the RBI’s last policy was a “dovish pause” and that a move is now necessary for effective monetary transmission. He explained, “For proper transmission of earlier rate cuts to come through the banking sector, a flatter and lower long end yield curve is required. With US cutting rates, would expect RBI to also move in same direction and long end government bonds look attractive.” This is crucial because lower US yields typically reduce the appeal of US bonds, potentially attracting Foreign Institutional Investor (FII) money into emerging markets like India.
Naval Kagalwala, COO & Head of Products, Shriram Wealth Ltd, noted that the FOMC’s move also included pulling back from its quantitative tightening program, following concerns around short-term funding for select banks. He observed that while policy easing was along expected lines, “treasury yields edged higher after Fed chair Powell noted that a further reduction in interest rate in the upcoming meeting in December was not a ‘foregone conclusion’.” This cautious approach caused the yields to move higher, particularly in the near end of the curve (the rate-sensitive segment).
From the Indian markets perspective, Kagalwala stressed that the focus now shifts to trade negotiations between India and the US, understanding the extent of INR depreciation, and the RBI’s liquidity management approach, given increased discussion around the possibility of the central bank doing Open Market Operations (OMO) purchases to lower the yield curve and support bank deposits growth.
Overall, the Fed’s action provides the RBI with greater flexibility to ease policy, provided domestic inflation remains contained.
