The Federal Open Market Committee of the US Federal Reserve left interest rates unchanged, but its members said rate cuts next year could be much lower than they had projected three months ago as the US economy and the jobs market have been more resilient than expected.

The US central bank is expected to keep real interest rates higher for a long period of time, which could, in turn, force the Reserve Bank of India to keep interest rates in India high for long.

High food inflation, rising oil prices, and the Fed's latest hawkish pause could force the RBI to maintain a hawkish stance well into 2024.

The outlook has turned somewhat bearish for stocks, which recently hit record highs in India, because the Fed's stance as also high oil prices could keep the rupee weak and slow capital inflows into the country.

Hawkish Pause

Late Wednesday, the Fed said it was leaving its target range for federal funds rate unchanged at 5.25-5.50%. This was as expected.

The Summary Of Economic Projections, an accompanying statement where Fed's members give their individual projections for growth, inflation, and interest rates, showed that Fed officials are betting a soft landing for the US economy, which means that the US central bank will have to maintain a restrictive stance for a long time to drive inflation to the mandated 2% level.

The most hawkish part of the projections, particularly for the markets, was the shift in the median forecast for the 2024 Fed rate to 5.1% from 4.5% made in June.

This means the FOMC members have shaved off 50 basis points of interest rate cuts they had projected for next year.

Bond yields rose and stocks fell after this information came out.

Separately, most members signalled they were keeping room for one more 25-basis-point increase in the Fed rate by December. The SEP projections showed the terminal policy rate is 5.6%, which means a target range of 5.50-5.75%.

As for the decision for the September meeting, FOMC reckoned that it had done enough by driving up interest rates by 525 basis points in over a year's time. The committee felt it needed to take a breather as the effects of the past cuts were still playing out on inflation, job growth, consumer spending, and overall economic growth.

The economy has shown resilience, with growth, consumer spending, and job growth not crashing due to the Fed's rate hikes.

Other Highlights of the Fed's meeting were:

• The implied real policy rate projections were moving higher in 2024 due to the projection of a high nominal Fed rate.
• GDP growth was revised upwards for 2023 and 2024.
• Unemployment rate projections were lowered but showed a moderate contraction in job growth.
• Inflation is expected to fall to the 2% target in 2026.

Higher For Longer

Indian policymakers have repeatedly said in the past that there is no one-to-one link between the interest rate decision of the US and India. But the MPC will likely keep a close watch on the Fed for likely actions back home.

If the Fed hikes rates by another 25 basis points, the gap between RBI's repo rate and the Fed rate could narrow to less than 100 basis points. While not many expect the RBI to raise interest rates in India in the current cycle, they do expect the Indian central bank not to cut interest rates anytime soon.

Over the last few months, expectations of a cut have shifted from October to December to February and now to April. It is likely that expectations of rate cuts will shift even further.

Importantly, with Fed officials scaling down their rate cut projections in 2024, interest rate cuts in India could become very shallow. At best, rates could be cut by 50 basis points in India in 2024-25.

The RBI will hope not to lower the spread between the Indian and the US interest rates as a shallow spread could hurt capital inflows and pressure the Indian rupee. High oil prices and tight US money markets weakened the rupee to a record lower earlier this month.

The markets will have to work with an assumption that interest rates, like in the US, will remain high for long in India as well.