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When the pandemic struck in 2020, central bankers across geographies found themselves galvanised together to safeguard their respective economies. From the US Federal Reserve to the European Central Bank across the pond and Asian counterparts ranging from the People’s Bank of China to the Reserve Bank of India, every bank axed policy rates and increased liquidity. They granted the markets their wish — barrels of low-cost money to tide over tough times.

What central banks wished for was a swift recovery in demand and employment.

What they really wished for was building and burnishing their credibility.

What central bankers faced later on is well known. They got a two-for-one prize with inflation surging everywhere even as demand climbed. After the nail-biting two-year sizzling inflation episode which made central banks look like a beaten-up pinata of a birthday party gone wrong, they are back again granting the market’s wishes.

The Fed cut its policy rate yesterday for the first time since 2020 and this time it again gave what the markets wished for and then some. A deep 50 basis point cut in the fed funds rate has taken many by surprise. After all, Jay Powell showed extreme reluctance in softening his stance on inflation even two months ago. The inflation data since then hasn’t been one that could warrant a super-sized rate cut.

This is where the unease under all the exuberance in the market appears. The fact that rate cuts have begun with a bang was enough to drive equity markets up with both the S&P and the Nasdaq gaining big. But US bonds weren’t as exuberant as expected and equity indices in Asia and elsewhere showed a more measured response.

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Investors are now worried that the super-sized cut, which is normally reserved as a response for crisis or unexpected event, is likely a response to a more-than-feared weakening of the US economy. That means a soft landing is not a given, yet. So far, a majority of fund managers believe that the US economy will weather high interest rates as our Chart of the Day shows.

While investors fret over the US, India’s stock markets have gotten more good news than they can handle, boosting an existing rally. As such, India’s equity and bond market didn’t need more good news for a rally. Benchmark equity indices have been hovering near record highs despite valuation concerns and the bond market rally is going strong for over a year now. A Fed rate cut acts as a cherry on top of this cake for India.

That said, the pressure is going to mount on the RBI to begin its rate cuts as early as next month. A quick Moneycontrol Poll showed that economists don’t see a material change in outlook after the Fed’s cut and only 3 out of 18 economists expect the RBI to cut rates as early as October. Ananya Roy explains why the RBI should pivot now and what we should expect for the equity markets in her column here.

The RBI is gunning for credibility as well, something that has been burnished ever since it adopted the inflation targeting regime. Though its inflation forecasts tend to miss the actual trend at times, the central bank and its rate-setting committee are held in high regard when it comes to price stability. The RBI is loath to lose this credibility which is why it is reluctant to bring down policy rates even though many in the market are pointing out that average inflation is near its desired 4 percent level. Nomura analysts recently pointed out in a report that the central bank should cut policy rates as early as October and they expect a cumulative cut of 100 basis points by end of 2025. Analysts at Motilal Oswal Financial Services Ltd believe that GDP growth this fiscal year would undershoot the RBI’s projection of 7.1 percent significantly to be 6.1 percent.

What is keeping the RBI from loosening its stance?

Food inflation, which is volatile and out of direct monetary policy control, is the single biggest bugbear for the RBI right now. As stated earlier, the central bank is loath to lose credibility and a decade ago, it faced the same dilemma when food inflation spiralled into a broad-based elevated inflation. That dent to its credibility is something the RBI never wants to face again.

While the markets may wish the central bank would begin rate cuts next month, will it grant them is a key question. Also, even if the wish comes true, a 25 basis points repo rate cut would hardly make borrowing cheaper for firms. All it may do is boost an already frothy equity market or lower the government’s borrowing cost. The markets must be careful of what they wish for.

Investing insights from our research team 

Will the RBI toe the US Fed line on rate cut?

Weekly Tactical Pick: Why this mid-sized private bank merits your look

Has Sharda Cropchem weathered all the challenges?

What else are we reading?

How a slow-mover NTPC built a renewable energy powerhouse

Personal Finance: Redefining the role of a savings bank account

Why the strike at Samsung’s Chennai plant is not just Stalin’s headache

How are successful startup hubs created?

Why Foxconn’s next bid for growth is a room on wheels (republished from the FT)

India's Digital Transformation: Empowering MSMEs for e-commerce growth

China's Guotai, Haitong securities merger resembles the Swiss model

Kolkata Hospital Rape and Murder Case: Hurried investigation and trial need not necessarily dispense justice

Tech and Startups

Yatra in growing-up phase, focus is now growth as well as profitability, says CEO Dhruv Shringi

Technical Picks: HDFC Bank, Adani Enterprises, Mahindra and Mahindra, SBI, EMS.

We have a crack team of reporters writing on everything startups and tech. We are fans of their newsletter Tech3 that lands in our inboxes every weekday evening. You can catch up on the day's happening tech and startup stories, including news, scoops, and analyses. If you have not already subscribed to it, click on this link to sign up.
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Aparna Iyer
Moneycontrol Pro