Ever since global central banks embarked on their monetary tightening cycle two years ago, financial markets have been overreacting to even small signs of a reversal in policy statements. Therefore, investors should not read too much into the 1 per cent rally in US stock indices and the rebound in Indian markets after the US Federal Open Markets Committee (FOMC) concluded its latest meeting on Wednesday.

The FOMC decided to stand pat on the Fed Funds Rate at 5.25 per cent to 5.5 per cent, did not make changes to its rate projections and made all the usual noises about being committed to getting inflation down to the 2 per cent target. But there were three distinct signs in the policy statement, which suggested that the US Fed is pivoting from a single-minded focus on inflation to striving for a balance between growth and inflation. Chairman Jerome Powell spoke of the FOMC’s ‘dual mandate’ of promoting maximum employment along with stable prices for the American people. This is in contrast to earlier rhetoric about ‘doing whatever it takes’ to get inflation down to 2 per cent. He unequivocally said that the policy rate was at a peak for this cycle and that if the economy evolved as expected, the Fed would ‘dial back’ policy restraint later this year.

FOMC members also stayed with their projections for the Fed Funds rate to fall to 4.6 per cent by end-2024. In the meeting, the FOMC discussed ‘slowing the pace of decline’ in bond holdings. The liquidation of the Fed’s $7.3 trillion bond stockpile has been haunting financial markets for a while now and this suggests a pause in liquidation. He noted progress on inflation control without making any specific mention of the recent spike in US CPI inflation to 3.2 per cent in February. This seemed to give US bond markets confidence that their expectations for three rate cuts from June 2024 would come good. This is why the policy announcement triggered a further fall in US 10-year treasury yields to 4.27 per cent, from their peak of 5 per cent in October 2023.

In recent times, India’s Monetary Policy Committee (MPC) has not had to follow strictly in the footsteps of the US Fed or Western central banks in deciding on the direction of policy rates. This is because India’s improving balance of payments and the resilient rupee have attracted foreign portfolio investment (FPI) flows to the country on its own merits. But if US rates head decisively down, policymakers may need to budget for the opposite problem — that of Indian markets attracting too much FPI money. India’s strong GDP growth prints in recent times, the expectation of political continuity post-elections, and imminent inclusion of government bonds in global benchmarks are all leading to global investors reassessing their India allocations at this juncture. Should this lead to a large influx of foreign money, there would be a live risk of new bubbles inflating in stock and bond markets and a sharply appreciating rupee. This calls for vigilance from the MPC, Reserve Bank of India and the markets regulator.