The Federal Reserve is the trailblazer for other central banks, but one cannot help but draw parallels between the Reserve Bank of India's position last month to that of the Fed's last night.

Both the central banks left the markets with more questions.

Wednesday, the US Federal Reserve raised interest rates by another 25 basis points and tweaked its statement to indicate a pause in further hikes. But it did not commit to interest rate cuts, which left the markets fretting.

The RBI had left interest rates unchanged at its last meeting in April but laboured to point out that it was not done with rate hikes, leaving the markets in limbo.

A further hike is not completely off the table in either of the countries, although both the central banks now seem to have set a very high bar for themselves for further rate hikes.

The markets would start to price-in rate cuts, but such positions could, at best, be tentative, till such time the central banks make a decisive shift in stance.

Due to the absence of conviction about the future of the central banks' moves, the markets will be volatile: reacting to each bit of economic data on how these would impact inflation or growth.

Fast and Furious

The Fed raised interest rates by 25 basis points to take the target rate for federal funds to 5.00-5.25%, which is a 16-year high. This was the Fed's tenth consecutive rate increase and its fastest pace of increase in 40 years.

The Fed has been raising rates since March 2022 from a near-zero level.

Like what the RBI's rate-setting body said last month, the Fed, too, said it would gauge the impact of past rate hikes. But unlike the RBI, the Fed has to take into account developments in the banking sector for its rate moves, not just the disinflation process or the growth sacrifice.

Financial market conditions, in contrast, have been fairly orderly in India and have not been a pressing matter for the RBI. The FOMC members toned down the stance, which the markets took to mean that Fed could hold interest rates at these levels for some time.

The FOMC statement omitted the line "additional policy firming may be appropriate" from its previous statements. Instead, the latest statement read, the Committee will monitor data to "determine the extent to which additional policy firming may be appropriate" to bring inflation to 2%.

This change in the wording meant the Fed has signaled a pause.

Hawkish Pause?

Addressing the media, Fed Chairman Jerome Powell countered that assessment.

"A decision on a pause was not made today," he told the media.

Powell also said the Fed could continue hiking if economic data points the central bank in that direction.

"We are prepared to do more if greater monetary policy restraint is warranted," Powell said.

Two other comments from Powell disappointed the markets as they signaled hawkishness.

First, Powell said more data would be needed to conclude if the Fed's interest rate hikes were restrictive enough to bring down inflation.

Second, he said it may be too soon to cut interest rates.

"We on the committee have a view that inflation is going to come down not so quickly," he said. "It will take some time, and in that world, if that forecast is broadly right, it would not be appropriate to cut rates, and we won't cut rates.

The CME FedWatch tool shows that close to 50% of respondents see the federal fund's target range 75 basis points lower at 425-4.50% by December. But the market's reaction, falling shares, in particular, indicated that the Fed did not meet the key expectation of a dovish-sounding hike at its meeting this time.

Tale of Two Central Banks

The June meeting will probably confirm if the Fed is opting for a pause.

"We'll be driven by incoming data, meeting by meeting, and we'll approach that question (of pause) at the June meeting," Powell said.

This is something very similar to what RBI Governor Shaktikanta Das had said in April.

He had said the decision to pause was only for the April policy as the central bank was taking time to assess the impact of past policy measures.

Deputy Governor Michael Patra supplemented that by saying the pause is valid only till Jun 6, when the MPC's next meeting concludes.

While the RBI had delivered a hawkish pause, the Fed has signaled one at its latest meeting.

Both the central banks are unlikely to hike rates now, although such a possibility exists. The RBI had not raised rates in April even though inflation had sped past its 2-6% target band in January and February.

Now with inflation falling below 6%, the RBI will find it tough to raise rates.

The minutes of the MPC meeting also showed that most members were not ruling out more hikes as vagaries of weather – heat waves, and unseasonal rains in North India – could renew the pressure on inflation.

Das had said the decision to leave interest rates unchanged was a tactical pause and was not a pivot or a change in policy direction.

The discussion about both the central banks will change in the coming weeks to about when they will start to cut interest rates. But both the central banks will try and be at their hawkish best as inflation is not yet fully in their grip.

Both the central banks would signal high for long, if not higher for longer. But the markets would not treat that as a win, as nothing short of rate cuts would do.

The coming months will be a season of extreme sensitivity to central bank speak and also of market gyrations.