US Fed cuts rates amid unclear outlook: impact on markets, including in India

• The US Federal Reserve cut interest rates Thursday by 25 basis points (or one quarter of a percentage point), the second reduction of 2024, while continuing to signal that inflation is coming under control.

Highlights:

• The recent 25-basis point interest rate cut by the U.S. Federal Reserve, following Donald Trump's election win, has significant global economic implications, particularly for emerging markets like India. Fed Chair Jerome Powell stated that future rate adjustments will depend on economic data, hinting that another rate cut may be possible in December.
• However, Trump’s economic policies, including potential tax cuts, tariffs, and immigration control, might heighten inflation and borrowing costs, potentially limiting the Fed’s flexibility for further cuts.

Impact on the U.S. Economy:

• The Fed's rate cut aims to stimulate spending by making borrowing cheaper. Reduced interest rates typically encourage households to purchase more goods and services and businesses to expand, leading to wage increases and growth.
• However, concerns arise with Trump's proposed fiscal policies, which could create inflationary pressures, potentially shortening the rate-cutting cycle. If inflation rises, the Fed might end its rate cuts sooner, which could affect global financial markets.

Implications for India:

• Foreign Investment and Currency Volatility: As U.S. interest rates decline, there is potential for increased foreign portfolio investment (FPI) in emerging markets like India, where the rate differential becomes more attractive. Lower U.S. yields could also spur more investment in Indian equities and bonds, but if Trump’s policies elevate U.S. inflation, this could cause rate hikes that might reverse FPI inflows.
• RBI’s Rate Decisions: The Reserve Bank of India (RBI), which has been cautiously managing inflation, will face pressure to navigate the effects of both U.S. rate policies and China’s stimulus measures. If the Fed’s rate cuts continue, it could provide RBI with some flexibility to consider easing rates. However, with inflation remaining a concern in India, the RBI’s December meeting will likely be critical in determining its stance.
• Global Trade and Economic Growth: Trump’s proposed tariffs on Chinese goods could slow China’s economy further, potentially destabilizing global supply chains. China has responded with another economic stimulus package focusing on debt refinancing and domestic support, which could make it more attractive for investors.
• Emerging Markets and Carry Trade: With U.S. rates lower, the “carry trade”—where investors borrow in low-interest-rate currencies and invest in higher-yielding emerging markets—becomes more appealing. India could see some inflows from these trades, although any rate hikes in the U.S. could reverse this trend and heighten currency volatility.

Longer-Term Effects and Outlook:

• For India, the Fed’s rate cuts could bring mixed benefits: an increase in foreign inflows and potential currency stability if the U.S. dollar weakens. Yet, Trump’s policies, particularly tariffs on China, could indirectly impact India’s supply chain and trade balances, necessitating careful monitoring by the RBI and policymakers.
• If global growth stabilizes and inflation remains manageable, emerging markets could stand to benefit from increased capital inflows.

Prelims Takeaways

• US Federal Reserve
• RBI’s Monetary Policy Committee