A Bold Move by the US Federal Reserve: The First Interest Rate Cut in Years
In a decisive shift, the US Federal Reserve has implemented its first significant interest rate cut since the onset of the Covid-19 pandemic.
Financial headlines boomed as experts made bold predictions on the Fed’s impending rate cut. Social media buzzed, analyst notes piled up, and all eyes were fixed on what would become a 50-basis point (bp) rate reduction.
Yet, when the decision was announced, the market barely flinched. Equities, bonds, and currencies responded with indifference.
This move is a 50-basis point reduction! However, it exceeded market expectations and highlighted the central bank's growing confidence in its ability to tame post-pandemic inflation.
As global markets brace for further action from other major central banks, in this article, we will discuss the implications of this rate cut that resonate far beyond US borders, finally reaching its destination, India.
2008 vs. 2024: The Fed’s Response to Economic Crises
While emergency rate cuts during COVID-19 temporarily altered monetary policy, the last significant 50-basis point cut by the Federal Open Market Committee (FOMC) occurred in 2008 during the global financial crisis.
While this might seem like a minor adjustment, it reflects a broader shift in economic thinking, with factors like ageing populations, deglobalisation, and higher productivity nudging the neutral rate upward.
At the heart of the Fed's monetary policy lies the concept of the “neutral rate” (r*), the interest rate that maintains full employment and stable inflation.
When inflation spikes, it signals that rates have fallen below the neutral point, whereas rising unemployment indicates rates have overshot it.
The challenge for central bankers is that they’re effectively navigating in the dark, making educated guesses about where this elusive rate lies. As of the Fed's most recent estimates, the neutral rate stands at 2.9%, up from 2.8% in June.
The Fed's decision mirrors changing expectations on Wall Street, where initial projections had favoured a smaller, 25-basis point reduction. The market’s reaction was swift and positive, with US equities rallying and India’s financial markets expected to follow suit.
Rationale: Inflation Control & Labor Market Stability
In a press conference following the rating announcement, Fed Chair Jerome Powell emphasised the Fed’s commitment to sustaining economic growth and stabilising the labour market. Powell described the move as a “recalibration” of monetary policy to support long-term growth and inflation targets.
With inflation appearing under control and the labour market stable, the Fed's decision to move by 50 bp might seem excessive.
By front-loading rate cuts, the Fed aims to solidify economic stability, ensuring inflation remains in check while minimising risks to the broader economy.
Yet, even with the larger cut, the Fed’s path remains uncertain. While the neutral rate is theoretically closer, the real challenge lies in avoiding a policy misstep. A rate cut that’s too shallow risks prolonging inflation, while an overzealous reduction could trigger a recession.
Powell’s key message was clear: while the Fed is prepared to adjust its policies in response to changing economic indicators, there is no "preset" path for future rate changes. This flexible approach suggests that while inflation may be easing, the Fed remains vigilant about potential risks to the labour market.
The 1977 Mandate: Maximum Employment & Stable Prices
The Fed’s modern statutory mandate, codified in the 1977 amendment to the Federal Reserve Act, requires the central bank to promote maximum employment and stable prices.
These two objectives—often called the Fed’s dual mandate—are central to its decision-making process.
The post-meeting statement indicated that the FOMC has greater confidence in inflation moving toward the 2% target. However, Governor Michelle Bowman dissented from the 50-basis point cut, advocating for a more conservative 25-basis point reduction. This dissent marks a rare occurrence, as it’s the first time since 2005 that a Fed governor has cast a dissenting vote.
The Dot Plot: A Glimpse Into Future Rate Cuts
In addition to the immediate cut, the FOMC’s dot plot—used to map officials' interest rate projections—suggests the possibility of 50 more basis points of cuts by the end of the year.
By 2025, an additional full percentage point reduction is expected, with a further half-point decrease anticipated in 2026.
Global central banks, including the European Central Bank (ECB), are also adjusting rates to balance inflation control and economic growth. The ECB recently trimmed rates by 25 basis points to 3.5%, signalling a cautious approach to monetary easing.
Market Reactions: Wall Street, Emerging Markets, and Investor Sentiment
The market expectation for a 50-basis point cut had surged in recent days as data from the CME Group’s FedWatch Tool showed a sharp rise in the odds for such a move. Wall Street welcomed the rate cut with a rally, and emerging markets like India stand to benefit as well.
As borrowing costs decrease in the US, global markets may experience a reallocation of funds, particularly into emerging markets, which offer higher returns. India’s equity markets, buoyed by strong domestic growth, could see increased foreign investment.
India's Stock Market Surge: Breaking Down the MSCI Benchmark Shift
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India’s share in the MSCI All-Country World Index, a key global benchmark for investable stocks, recently rose to 2.33%, surpassing China’s 2.06%.
This development has propelled India to the sixth-largest weighting in the index, dominated by US companies.
The shift highlights the burgeoning equity market, which has benefitted from increased liquidity, stronger investor interest, and a series of high-profile initial public offerings (IPOs).
Key Data Pointers:
As China grapples with an economic slowdown and fund managers divest from Chinese stocks, India’s appeal to global investors is stronger than ever. The rebalancing in the MSCI index reflects this sentiment, with Indian stocks gaining greater visibility and accessibility for international portfolios.
Why the Shift? Economic Context and Market Dynamics
Several economic and market factors contribute to India’s newfound dominance in global indices.
First, India’s economy has emerged as the fastest-growing among major global economies, with GDP growth outpacing both developed and emerging peers.
Second, China’s economic struggles, characterised by slowing growth, mounting debt, and declining foreign investments, have created a vacuum in the investor landscape—one that India is rapidly filling.
Supporting Data:
The rise in India’s equity market is a result of external factors and also driven by internal structural improvements. The re-elected government has been actively pushing reforms, enhancing the ease of doing business, and fostering a start-up ecosystem that has attracted billions in venture capital and IPO activity.
The Rise of Indian Gold
In another striking development, India's gold imports hit a record $10.06 billion in August, with approximately 131 tonnes of bullion entering the country. This surge came after the government reduced gold import duties by 9 percentage points in July, sparking renewed demand in the world's second-largest market for gold.
Lower interest rates in the US, which make non-yielding assets like gold more attractive, have been a driver of the metal’s price increase. The Fed’s 50 bp rate cut pushed gold prices to nearly $2,600 per ounce, adding further fuel to the rally.
Despite the resurgence in demand, analysts warn that the benefits of the tariff cut may soon be overshadowed by rising gold prices.
Already, domestic prices in India are approaching pre-cut levels, prompting questions about whether consumers will continue their buying spree.
Three-Pronged Impact: Currencies, Growth, and Foreign Investment
The ripple effects of the Fed’s rate cut will be felt across global economies, particularly in emerging markets like India:
Final Thoughts: A Race to Adjust Policy Rates
In a busy week for central banks worldwide, attention will also be on upcoming decisions from the Bank of England , South Africa’s Reserve Bank, and Norway’s Norges Bank , among others. Meanwhile, the Reserve Bank of India (RBI) ’s Monetary Policy Committee meeting, slated for early October, will provide further clarity on how global rate changes might influence Indian monetary policy.
India’s rise in global financial indices is a reflection of its growing economic stature and market potential. As investors increasingly shift focus from China to India, opportunities abound for those looking to tap into the next wave of emerging market growth.
The Fed’s rate decisions and India’s growing influence in global markets highlight the complex interplay of monetary policy, investor sentiment, and economic growth. Whether navigating the Fed’s neutral rate or betting on India’s stock market, the stakes have never been higher.