Opinion Express view on US Fed cut: A signal to RBI to rework policy

On Wednesday, in its last meeting of the calender year, the US Federal Reserve cut interest rates by 25 basis points. This was expected. The target range for the federal funds rate is now at 4.25-4.5 per cent. The Fed’s forward guidance was, however, distinctly hawkish — it has now projected only two rate cuts next year, down from its earlier projection of four cuts. In fact, Fed Chairman Jerome Powell acknowledged that the decision to cut rates was “a closer call” this occasion. He added that “from here it’s a new phase and we’re going to be cautious about further cuts”.

Inflation has been stubbornly high. As per the projections accompanying the December inflation, as measured by the personal consumption expenditures, is now expected by Fed officials to be at 2.5 per cent in 2025, as opposed to earlier expectations of 2.1 per cent. In 2024, inflation is at 2.4 per cent. Assessment of future policy rates and the inflation trajectory will also have to factor in changes in policy under a new White House administration. There are expectations that Donald Trump will announce tariffs on major US trading partners — a move which will be inflationary — and will also cut taxes – which will raise the government deficit. If these fructify, it would force the Fed to keep rates high for long. In his comments, Powell did say that “some people did take a very preliminary step and start to incorporate highly conditional estimates of economic effects of policy into their forecasts at this meeting”. Fed officials now expect interest rates at 3.9 per cent in 2025, as against earlier expectations of rates being at 3.4 per cent.

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Reverberations from the Fed’s actions were felt across markets — US bond yields rose, global stocks fell and the dollar strengthened. The S&P 500 ended the day down 3 per cent. Asian markets mirrored the decline with the Nikkei falling by 0.7 per cent, Hang Seng by 0.5 and Kospi by almost 2 per cent. The BSE Sensex was also down 1.2 per cent. The Dollar index rose to 108.26 — its highest level since November 2022. The Indian rupee breached the 85/dollar mark in early trade. There is now an expectation that the Fed will take a pause on rate cuts in its next meeting in January as it awaits greater clarity on the policies of the Trump administration. For RBI, the policy choices are narrowing as the pressure on the currency intensifies.