Fed Holds Rates Steady: What Does Mean for Global Economies?

Why in news?

Financial experts initially predicted a rate cut by the Fed in May 2024, with some expecting even three cuts throughout the year.
However, the Fed surprised markets by maintaining its current rate.
This cautious approach stems from inflation exceeding expectations, reaching 3.5% year-on-year in April. Fed Chair Jerome Powell emphasized that inflation remains “too high” and rate cuts will be contingent on “greater confidence” in price growth declining towards the target 2%.

The delayed guidance on rate cuts and the mention of a possible future hike dampened investor enthusiasm. Stock markets initially rallied but closed mostly down as investors digested the news.

The Fed’s monetary policy decisions, like those of other central banks, significantly impact employment and inflation.
Their primary tool is the federal funds rate, which influences borrowing costs for businesses and consumers, ultimately affecting economic growth.
Lower interest rates make borrowing cheaper, encouraging households to spend more and businesses to invest and expand.
This increased demand for goods and services translates to higher wages and a stronger economy.
While the effects aren’t immediate, monetary policy plays a crucial role in managing inflation and fostering economic growth.

Traditionally, rate cuts in the US have a positive effect on emerging economies like India, especially in terms of debt markets.
Emerging economies typically have higher interest rates than developed countries. This creates an opportunity for investors, known as Foreign Portfolio Investors, to borrow in the US at lower rates and invest in higher-yielding Indian bonds.

A US rate cut could potentially impact India in three ways:
- Currency Carry Trade: A wider interest rate gap between the US and India could make India more attractive for the currency carry trade, where investors exploit interest rate differentials.
- Global Growth Momentum: A stronger US economy, fueled by lower interest rates, could positively impact global growth, benefiting India, especially considering China’s current economic slowdown.
- Emerging Market Investments: Lower US returns might trigger a shift towards emerging market equities, including India, potentially attracting more foreign investors.

The Reserve Bank of India (RBI) is likely to consider the Fed’s actions when making its own decisions on rate cuts.
In April, the RBI kept its repo rate unchanged, hinting at a potential drop in inflation by the second quarter of FY 2025.
This has fueled expectations of a rate cut later this year, but it’s highly probable that such a move would happen only after the Fed adjusts its rates.

The US Fed’s decision to hold rates steady reflects its cautious approach towards inflation. While this might disappoint those expecting a rate cut, it has broader implications for global markets. Emerging economies like India stand to benefit from increased investment opportunities and a potentially stronger global economy.
However, India’s own rate cut decisions will likely depend on the Fed’s future actions as both central banks navigate the complexities of inflation and economic growth.