US policy differences will require monitoring as Fed rate cuts spark debate

The Federal Open Market Committee (FOMC) of the United States (US) Federal Reserve on Wednesday lowered the policy interest rate, the target range for the federal funds rate, by 25 basis points to 3.5-3.75 per cent, taking the total reduction in the current cycle to 175 basis points. Since there had been some doubt in financial markets about the rate action, the delivery of a rate cut pushed stock prices higher. However, the market’s doubt was not unfounded. Two members of the committee voted against the decision to cut, while President Donald Trump’s recent appointee, Stephen Miran, wanted a 50 basis point cut. It is worth noting that the Fed’s economic projections showed that four other members were also not in favour of a rate cut. Expectedly, Mr Trump was disappointed by the Fed’s decision and wanted a bigger rate cut to enable faster growth. Clearly, the US has policy divisions at various levels. The way these differences play out next year will shape outcomes not only for the US economy but for the global economy more broadly. 

Fed Chairman Jerome Powell, in his remarks, said the policy interest rate was now in neutral territory, which means it is neither expansionary nor contractionary. This might be a little confusing for the markets because the projection suggests that the inflation rate will come down to 2 per cent only in 2028. This also perhaps explains why several FOMC members were against a rate cut this week. Thus, the Fed will now likely wait and see how the economic conditions evolve over the coming months. Mr Powell has argued that tariffs are causing inflation to overshoot. Though he is of the opinion that it is likely to be a one-time increase, the impact will be worth watching. In fact, while the US economy is doing reasonably well, partly because of artificial-intelligence-related investments, hardly any of the stated objectives of increasing tariffs seem to be materialising. China, for instance, continues to post a record trade surplus and has possibly found a way to deal with the disruption. 

Be that as it may, the Fed may not necessarily be data-driven in 2026. Mr Powell’s term is ending in May, and a lot depends on the next chairperson. It is well known that Mr Trump believes interest rates need to come down significantly and would most likely appoint someone with the same view. Although the new chairperson may not be able to drive the agenda immediately, there will be questions about the possible implications for the Fed’s independence and how potential compromises could affect financial markets. Bouts of instability in global financial markets could increase challenges for India. The rupee is under pressure owing to capital outflows, particularly from the equity market. For the near term, the Fed has decided to resume buying Treasury bills to increase liquidity, which should help improve financial conditions. However, from India’s point of view, the focus will be on the ongoing trade negotiations with the US. A mutually favourable deal will be more significant for India’s external account than short-term policy interest-rate changes. A trade deal will improve flows on both the current and capital accounts. Assuming a trade deal is signed in the near future, from an external-account perspective, the transition at the Fed will be the next major development to watch.