The market got what it wanted. Rather, what it expected. But that has not triggered the move that the markets were expecting, as the Federal Reserve has kept the door open for more rate increases at its July monetary policy meeting.

The suspense continues, and the markets do not like that.

Going into the Federal Open Markets Committee (FOMC) Meeting, the markets hoped the US central bank’s rate-setting body would hike rates instead of skipping it as was done in June, as such a move would signal that rates have peaked.

This could have prompted the markets to start pricing rate cuts in the coming days.

But the Fed has kept the room open for more rate hikes, and the search for the elusive peak rate remains.

This would mean the Reserve Bank of India has another reason to keep its monetary policy hawkish in August. It may not even change the stance to neutral, as was hoped.

Hangs In Balance

Late Wednesday, FOMC members voted unanimously to raise the target rate for federal funds, the 11th hike since March 2022, to 5.25-5.50%.

The Fed rate now stands at its highest level in 22 years.

The rate hike came as expected, as the market had attached a 99% probability to such an action.

The FOMC statement was largely identical to the June one, when the rate-setting body had decided to pause. This means rate hikes are still on the cards, although some market segments hope that Fed will not raise rates again in this cycle.

The swap market is attaching a 50:50 probability to one more rate hike by December.

To that extent, the Fed could continue with its start-stop approach. Even if the Fed pauses again in September, a hike in November or December cannot be ruled out.

Chairman Jerome Powell repeatedly said that the Fed would be data-dependent and that the rate-setting body would not go into the meeting with a pre-set plan. He did not hint at what parameters the Fed would track to hike rates.

“We’re going to look at two additional job reports, two additional CPI reports, lots of activity data. That’s what we’re going to look at, and we’re going to make that decision then. That decision could mean another hike in September or it could mean that we decide to maintain at that level,” FOMC chairman Jerome Powell said about the next Fed meeting without offering any cues.

To that extent, the market has nothing concrete to go with and will have to react to each economic data set in forming expectations around what the Fed might do next.

A side note from the Fed but of some import is that economists that work at the Fed have forecast that the US economy will not go into recession. Fed staff’s predictions are independent of FOMC members’ own forecasts.

If the US rate-raising campaign is not triggering a recession, the Fed will not be in a hurry to cut interest rates either. Powell did say that decision will be on the table one full year from now.

“That (rate cuts) won't be this year; I don't think. Many people wrote down rate cuts for next year. I think the meeting was several for next year. That's just going to be a judgment that we have to make then… a full year from now. It will be about how confident we are that inflation is in fact coming down to our 2% goal,” Powell said.

Hawkish Pause

The RBI’s MPC will meet Aug 8-10 and will mostly likely maintain the same posture – of holding rates while standing ready to hike if needed.

The RBI is unlikely to cut rates until the Fed is likely to keep the option of hiking on the table.

RBI officials and also external members have said there is no link between the moves of the FOMC and the RBI. But in all probability, the MPC will not ease up till the Fed is hiking.

An unfavorable interest rate differential could hurt exchange rates and slow capital inflows and cause macroeconomic disruption, which the central bank would want to avoid.

The RBI is still worried about food inflation and how that will impact overall inflation. The Indian government’s decision to curb rice exports could hurt global food prices and spread to items India imports.

In this context, the RBI’s move and stance are unlikely to undergo any changes.

The RBI may offer more analytics around inflation, especially food inflation, and how it will counteract other items.

The paper by RBI’s economists noted, although in the global context, that there were price spillovers. Prices in one commodity group are impacting prices in other groups even if the consumption pattern is dissimilar.

Moreover, the so-called last mile of inflation reaching the targets will be most difficult to reach.

The MPC does not have enough reasons to hike interest rates next month, but it has enough grounds to sound as hawkish as it did in June if not more.

The Indian markets are now prepared that RBI will not cut interest rates in this financial year. To that extent, the only cues the market will look for from the RBI is if the pivot to rate cuts moves deeper into the next financial year.