US Fed pivot: Does the FOMC policy rate verdict impact global central banks? Here’s what 10-year data reveals

The US Federal Reserve recently delivered a super-sized interest rate cut of 50 basis points (bps), bringing its policy rate down to 4.75-5 per cent for the first time in four years. The US central bank maintained the key borrowing rate elevated at the 23-year high mark for 14 consecutive months since July 2023 to combat the worst inflation outbreak in almost 40 years.

D-Street experts now contemplate whether the Reserve Bank of India (RBI) will follow the US Fed bank's pivot and deliver a rate cut in next week's upcoming monetary policy meeting. However, historical data compiled by banks and brokerages show that most central banks move according to domestic conditions and are not necessarily linked with decisions taken by the US Fed.

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The Fed dot plot shows another 50 bps cut can be expected in the remainder of the year and then a cumulative 100 bps cut in CY25. “While this is more hawkish than expected, the view appears to originate from targeting the unemployment rate at 4.4 per cent next year and inflation at the targeted two per cent mark. The latest projections have lowered growth and inflation but indicated an increase in unemployment,” said Sonal Badhan, Economist, Bank of Baroda.

US Fed pivot: What made the US central bank cut rates?

Before the meeting, analysts were split between the possibility of a 25 bps or 50 bps cut, as macro data points provided mixed signals. While the labour market was showing signs of cooling down, core CPI noted some buildup in pressure in August 2024.

Also Read: US Fed lowers policy rate by 50 bps from 23-year high, signals additional 50 bps cuts; 5 key takeaways

US Fed chairman Jerome Powell highlighted that since the July policy meeting, the central bank examined two inflation and employment reports -July and August. The US Fed also got support as CPI eased to 2.5 per cent in August from 2.9 per cent in July, moving closer to the targeted two per cent mark on a durable basis. Another reason for a super-sized rate cut was that the central bank did not want to be behind the curve.

The Fed’s rate hikes have helped lower annual inflation from 9.1 per cent in June 2022 to 2.5 per cent. However, high rates have made borrowing costlier for businesses and households. According to economists, policymakers must keep rates high enough to defeat rising inflation without derailing the economy.

In the post-policy press conference, Powell admitted that the US Fed might have opted for a rate cut earlier if an inflation report was available during the July policy. The change in economic projections also supports their view.

Also Read: US Fed delivers supersized 50 bps rate cut: FPI inflows to stronger INR—here’s how the verdict is ‘good’ for India

Does the US Fed policy rate verdict impact global central banks?

Bank of Baroda analysed how global central banks moved when the US Fed delivered a rate hike or a cut. For the purpose of the analysis, economists have benchmarked the time period according to US Fed rate action.

Looking at the data for almost thepast 10 years, it was noted that while the US Fed action is an important guidance factor for other central banks, it is not a deciding factor. The decision to cut or hike rates is driven more by domestic factors.

For instance, between 2015 and 2019, when the US Fed was seen hiking rates, European Central Bank (ECB), Bank of England (BoE), and the RBI had mostly lowered rates. Before the US Fed began hiking rates in 2015, it had been on hold since December 2008, post the financial crisis.

Similarly, just before COVID-19 struck global economies, the US Fed had begun lowering rates, while other central banks were on hold. During the pandemic, in India, RBI delivered pre-emptive cuts to support the economy, even as other bank were either on hold or announced smaller quantum of rate cuts.

Post COVID-19, all central bank moved in sync and began hiking the benchmark interest rates. Most recently, while the US Fed, BoE and ECB have announced cautionary rate cuts, the RBI has maintained its repo rates steady so far.

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India-US 10 year rate differential

Over the last 10 years, the spread between India and US 10 year G-Sec has come down from the high of 871 bps (April 2014) to a low of ~200 bps (September 2023). The movement can be divided to two phases. In phase 1, policy divergence between the US Fed and RBI between December 2015 and June 2019 implied that spread between the two averaged ~558 bps. 

After this, as COVID-19 struck and both economies lowered rates until February 2022, the spread remained steady, averaging ~560 bps. During this period, both RBI and US Fed lowered rates. In the phase two, as major central banks started hiking rates, more aggressive stance of the US Fed compared with RBI, led to narrowing of yields (average ~346 bps) between India and US 10 year G-Sec. 

'This narrow spread remained until the end of last month. Only recently it has once again gone up, as US Fed delivered a significant rate cut, while RBI is likely to maintain rates on hold for now," said Sonal Badhan of Bank of Baroda.

Also Read: FPIs continue buying streak, invest ₹57,359 crore in Indian equities; Sept logs highest inflows YTD on US Fed pivot

Will RBI cut rates next week?

The RBI's Monetary Policy Committee's (MPC) stance continues to be disinflationary until a durable alignment of headline inflation with the target is achieved. RBI Governor Shaktikanta Das has repeatedly clarified that RBI actions are based on domestic factors. Food inflation pressures are showing little signs of abatement in the near term and MPC will be vigilant to potential spillovers of food price pressures to the core components.

“We thus, continue to believe that RBI will maintain policy rates unchanged in the upcoming October meet. The earliest possibility of a rate cut emerges only in December, as MPC members are likely to monitor the impact of excess rains and food inflation before deciding to lower rates. We believe the stance will also be kept unchanged in October , as there still remains liquidity surplus in the system,” said economists at Bank of Baroda.

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and individual circumstances may vary.