After adopting a distinctly dovish tone in its last two monetary policy meetings and raising market hopes for an early start to the easing cycle, the US Federal Open Markets Committee (FOMC) pulled back in its latest meeting on June 12.

The policy statement showed that the FOMC is back to its indecisive avatar while keeping policy rates on hold. The statement noted the ‘solid’ pace of expansion in the economy despite US GDP growth coming in at a two-year low of 1.6 per cent for the first quarter of 2024. It noted ‘modest progress’ towards the 2 per cent inflation target despite signs of cooling inflation.

It mentioned strong job gains and ‘low’ unemployment. Latest US payrolls data showed high job additions of 2,72,000 jobs in May, but a spike in the unemployment rate to the critical 4 per cent mark, a two-year high. Signs of a slowing economy and a below-forecast CPI print of 3.3 per cent, had led markets to budget for the Fed to cut rates as early as July and pencil in two-three rate cuts for the rest of 2024.

However, the much-awaited dot-plot, where FOMC members share their rate projections, has now forecast only one rate cut for 2024. The statement this time also saw no mention of the Fed’s plan to slow its pace of quantitative tightening, clearly outlined in the previous meeting, leaving markets confused.

US commentators have been increasingly arguing that early rate cuts may be necessary for the country to achieve a soft landing. The prop to consumer spending from excess savings amassed during Covid are already waning.

US housing starts have seen sharp declines from February as mortgage rates upwards of 7 per cent have deterred buyers. A letter to the Fed by US lawmakers, urging rate cuts in this meeting, pointed out that high interest rates were feeding into shelter costs and ironically propping up the very CPI that the Fed was trying to quell. Shelter costs in the US make up about a third of the CPI.

These indicators also suggest that the US Fed, by delaying its rate cuts too much, could put the US economy at risk of a sharp slowdown, undermining global growth prospects.

The Fed’s flip-flops also make it not just expedient, but necessary for other central banks to decouple their rate actions from the US. The European Central Bank, Bank of Canada, People’s Bank of China et al have already gone ahead with rate easing policies.

After the recent monetary policy meeting, the Reserve Bank of India Governor explicitly stated that he was not in the game of ‘Follow the Fed’ and would calibrate India’s monetary policy to local conditions. However, the RBI is sure to be aware that it would involve trade-offs on capital flows and the exchange rate, given that US remains the largest contributor of foreign portfolio flows to emerging markets such as India.

The unexpected election verdict and higher foreign investor participation in Indian bonds starting this month, will make this balancing act harder.

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