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On Wednesday, September 18, the Federal Reserve grabbed headlines with its bold decision to lower the benchmark interest rate by 50 basis points (bps), to a range of 4.75% to 5%. This marked the first major rate cut since the pandemic.
Interestingly, Fed member Michelle Bowman, the first governor in nearly two decades to dissent, pushed for a smaller 25 bps cut. Yet, the Fed's choice to opt for the larger cut of 50 bps raised eyebrows. Investors were left wondering if the Fed was responding to inflation and unemployment, or if it was taking pre-emptive measures in response to possible underlying economic problems.
Why the Fed Decided on a 50 bps Cut
The decision comes after months of high interest rates intended to control inflation. Federal Reserve Chair Jerome Powell in Washington explained that indications of a slowing inflation are the reason behind this rate reduction. "Greater confidence" has been expressed by the Fed that inflation is heading toward the 2% objective, according to Jerome Powell. Both The labor market and inflation figures have both decreased, which allows the Fed to take more aggressive action.
Jerome Powell said they didn’t cut rates because they were scared of an economic crash. He said, “The US economy is doing well, and this move is to keep it that way.” But he also mentioned that the Fed will keep an eye on new data and change their plans if needed. If inflation stays high, they might stop cutting rates, but if the job market gets worse, they might make more changes.
Future Rate Cut Projections
The Federal Reserve projects two more 25 basis point rate reduction in 2024, bringing the rate down to a range of 4.25% to 4.50%. The central bank projects a 100-basis point drop by 2025 and an additional 50 basis point reduction in 2026. According to the Fed's predictions, interest rates could decrease by 200 basis points in the coming years.
Assets' Response to the Rate Cut
· US 10-Year Treasury Yield: As investors shifted to safer assets, the yield on the 10-year Treasury decreased somewhat to 3.759%.
· Dollar Index: As a result of the US dollar's decline, the Dollar Index fell to 100.37, the lowest level since July 2023.
· Commodities: Brent Crude prices remained at $73.5 per barrel, while gold soared to $2,560/ounce (₹7,341/gram). The current state of the market is so unpredictable that investors are flocking to these safe-haven investments.
· Bitcoin: The cryptocurrency market benefited from the rate reduction as well, with Bitcoin rising to over $62,400.
Impact on India: Rupee and Bond Yields
The Indian rupee gained 18 paise in response to the Fed's rate drop, going from 83.86 to 83.68 against the dollar in afternoon trading. This rise was fueled by anticipations of higher dollar inflows into India due to the greater allure of investing in emerging countries such as India due to lower US interest rates.
On the other hand, the Fed's rate cut caused Indian bond yields to drop. From 6.779% to 6.758%, the yield on the benchmark 10-year bond (7.10% 2034) decreased. As investors go abroad for higher rewards, falling US rates frequently drive down global bond yields.
Why This Cut Was Expected
One big reason for the rate cut is the US government’s massive debt, which is now at $35 trillion. With nearly $1 trillion in annual interest payments, keeping rates high for too long would have been a huge financial strain. So, the rate cut was necessary to ease this burden.
Interestingly, the Fed had been prepping the market for this move. Over the past few weeks, Fed members hinted in interviews that a cut was coming, gradually building up market expectations, avoiding any market panic.
Conclusion: The Road Ahead
The Federal Reserve's attempt to ease borrowing when inflation declines is seen in their 50-basis point rate drop. Though it also begs concerns about potential hazards, this action demonstrates their faith in the economy. The enormous national debt of the United States continues to influence Fed policy.
Interest rates and the state of the global economy will be shaped in the future by the way inflation trends, economic data, and Fed policy unfold. Looking for indications of stability and clarity in the upcoming months, investors and policymakers will be closely monitoring the situation.
Thank you.
Regards,
Kautilya, IBS Mumbai.
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