7 mins read . 26 May 2023
When the US Fed published the minutes of the May FOMC meeting on 24th May, the big news was that the minutes indicated at a likely pause by the Fed. In May, the Fed had hiked its benchmark rate by 25 bps, taking the benchmark rate to 5.00% to 5.25%. The theme of the May policy was still inflation control, but the minutes suggest that members were veering more towards the pragmatic than towards the hawkish. Even as the stance of the Fed is still hawkish, the minutes are suggesting that the US could be close to the top. That is not surprising considering that there is a slowdown in GDP growth and a simmering banking crisis in the US. Pragmatism could rule the Fed stance in the coming months.
The CME Fedwatch allows readers to evaluate the probability of rate hikes or rate cuts over the next one year. Given below is a clustering of such probabilities.
Data source: CME Fedwatch
What does the cluster table above tell us about market expectations on the trajectory of rates going ahead post the minutes?
Essentially, the members want the Fed to retain optionality rather than getting married to a stance. The time for pragmatism may have finally arrived.
The relationship between interest rates and inflation has been well understood. Now members are focusing more on the likely trajectory of interest rates considering three key developments viz. GDP growth, bank closures and debt ceiling deal.
The gist of the Fed minutes is that the situation is very fluid and the Fed must keep a much optionality window available at this point of time.
When it comes to the Indian effect, it is a kind of a Blow Hot / Blow Cold situation. The problem is that the minutes have indicated a high probability of a recession in the fourth quarter of 2023. A recession is not just about the crimping of oil demand. It is also about hitting tech spending as well as pressure on Indian exports. Remember, India runs the largest trade surplus today with the United States. Indian markets have already been hit by the debt ceiling.
However, there is a positive side to the minutes too. The big takeaway from the Fed minutes is that global hawkishness may be coming to an end after almost 15 months. If the Fed actually pauses in June 2023, it will be an affirmation that much of the pain is over. India has traditionally gained from global dovishness. It has helped economic growth; stock market returns and portfolio flows. That should be a big boost for the Indian markets too.
One concern for the RBI would be on the policy front. It is hard to recollect the last time the US offered high rates, weak growth, a possible recession, a banking crisis, and a potentially explosive debt ceiling. The question is; how will the RBI tweak Indian monetary policy in such a situation of heightened ambivalence. The real struggle will be about regulatory handling of the repercussions of US policy.
Content Source: US Federal Reserve