The much-anticipated interest rate cuts are finally coming. The biggest hint came from the US Federal Reserve Chair Jerome Powell, who said last Friday that “the time has come for policy to adjust”. Losing no time, the US stock market shot up, while our own Nifty and Sensex jumped in tandem to reclaim the 25,000 and 82,000 marks, respectively, on Monday. The Fed last raised its benchmark interest rates in July 2023 and has held its key Funds Rate at 5.25-5.50 percent since.
The biggest question is if the rates will go down in the forthcoming easing cycle nearly as much as they went up. The market is pricing in a series of quarter-point cuts bringing down the benchmark rate by at least one full percentage point over the next year.
While a 25-basis-point cut in September seems likely, analysts suggest that sharper cuts could spark concerns about growth entering a recessionary phase. The market is abuzz with arguments about whether the Fed has been waiting too long to cut rates now, just as it waited too long to start raising rates two years ago terming the high inflation transitory.
Inflation in the US continues to hover above the sacred 2 per cent target, but has shown signs of easing and has printed at 2.9 percent in July, marking the slowest rise since March 2021. Elevated rates for a longer period also seem to have slowed down the US jobs market, which added fewer numbers than earlier estimated between April 2023 and March 2024.
Fed rate actions usually set off a chain reaction, particularly among emerging economies that tend to change rates in tandem, but it remains to be seen if the RBI will follow suit. Governor Shaktikanta Das has reiterated multiple times that its policy course will be determined solely by domestic factors, importantly inflation and growth.
Early this month, he flagged lingering concerns about high food prices and how the central bank will wait for a durable decline in food as well as headline inflation before kicking off a rate cut cycle. That said, lower rates in advanced economies like the US will help increase capital flows into markets like India, reversing the trend of outflows due to the uncertainty surrounding rates. As it is, valuations of Indian equities are stretched, so investors should temper expectations and avoid building froth in the market.