Message in the Fed Reserve rate cut

That the United States Federal Reserve would reduce interest rates in its September meeting was widely expected even though the jury was out on whether the reduction would be quarter or half of a percentage point. By deciding on the latter — federal fund rates are now in the range of 4.75%-5% — the US central bank has sent a clear signal that it is more concerned about cushioning the labour market than reining in inflation. Financial markets, both in the US and outside have taken the announcement in their stride and not shown wild reactions. This underlines the claim that the decision was largely on anticipated lines. What happens now?

Unlike the Reserve Bank of India, Federal Open Market Committee (FOMC) — US equivalent of India’s Monetary Policy Committee (MPC) — members give dot-plots of interest rate projections going forward. The projections indicate that rates could fall by another 50 basis points by the end of the year. FOMC also sees yesterday’s pivot as the beginning of a long phase of monetary easing with interest rates expected to be just under 3% by the end of 2026. What is the import of this pivot in US monetary policy?

If Fed chairman Jerome Powell manages to ensure a “soft-landing”, which would mean inflation aligning with the target rate without triggering a recession or high unemployment, he would go down as one of the most successful central bankers in the history of modern capitalism. Tailwinds from lower mortgage costs could also help the Democratic Party in its bid to regain the White House. As a corollary, the decision also risks a backlash against the Federal Reserve’s independence if Donald Trump were to win the November presidential elections.

Because the US is the largest economy in the world, and the dollar the dominant currency, its monetary policy stance is consequential for the rest of the world too. What will it mean for India? Expect MPC to dial down its hawkish rhetoric for sure even if there is no rate cut in the October meeting. More importantly, a return to the days of cheap money could also end the ongoing bear phase in long-term investment flows such as from the venture capitalist route for start-ups in the Indian economy. Both of these are good news for medium-term prospects of the Indian economy.

To be sure, cheap money has its own set of complications but that is not something which would concern markets and policymakers at the moment. The world and US monetary policy has a lot of distance to cover before it gets there.