The US Federal Reserve, which had been proceeding cautiously in rolling back the 525 basis points increase in Federal Funds rate done between March 2022 and July 2023, has begun the rate cutting cycle with a bang. It delivered a large 50 basis points cut in the federal funds rate in its recent meeting, bringing down the range of its target fund rate to 4.75 to 5 per cent. Financial markets have been particularly overjoyed by the projections of Federal Reserve Board Members and Federal Reserve Presidents, which indicate another 50 basis points cut by the end of this calendar year, followed by 100 basis points cut in 2025. Easing credit market conditions in the US will increase the funds available to global investors.

With central banks of other advanced economies such as Bank of England, European Central Bank, Sweden and Switzerland already having begun cutting rates, the Fed has been slightly behind the curve. The larger than expected rate cut therefore appears intended at catching up with its peers. Macro data has been supportive of the Fed’s decision. With the PCE (Personal Consumption Expenditures) inflation in US moving down to 2.2 per cent in August, and the core PCE moving lower to 2.7 per cent, the US Fed had the room to embark on the rate-cutting cycle. The easing of tight conditions in the labour market with lower job additions in the last three months and slower increase in wage growth appears to have given the Fed further comfort that inflation will be under check. The rate cut is expected to help consumption, which has stayed stable and further boost the nascent revival in capital investments.

Equity markets across US, Europe and Asia have notched up strong gains since the Fed announcement. While the reaction of Indian stocks was muted on Thursday, it has recorded strong gains the next day. Gold hit record highs and sovereign bond yields of emerging markets have hardened. This positive reaction is on account of the significance of the borrowing cost in US for global fund flows. With investors from the US accounting for more than half the global investible funds, declining interest rates will increase their corpus, which will flow across regions and major asset classes. The weakness in the dollar after the rate cut also portends that funds will move out of US treasury securities into riskier assets such as emerging market equities and bonds.

Domestic sovereign bond yields have been softening since last October; therefore, their reaction to the Fed announcement was quite tepid. But the Fed rate cut has increased the spread between the yields of the US and Indian government bonds, which will help attract more foreign portfolio flows into debt. Availability of cheaper credit will boost FDI and NRI remittances, which augurs well for the rupee. The RBI, however, is unlikely to toe the line of the central banks of advanced economies, given lingering concerns over inflation. India’s macro-prudential indicators are robust enough for monetary policy to be focused on domestic issues.