With the Federal Reserve maintaining its expected stance, the focus turned to Chair Powell’s press conference. Given the recent disappointing progress in curbing inflation, the Committee will need more time than anticipated to be confident that inflation is steadily returning to target and that rate cuts are warranted.

Simultaneously, Powell played down the likelihood of further rate hikes and emphasized that policy remains tight. He cited a slowdown in labor demand and softness in interest-sensitive spending, particularly in housing and capital investment, as consequences of the tight policy. Powell outlined three probable scenarios, none of which included rate hikes: (1) persistent inflation = no cuts, (2) declining inflation = cut, (3) weakened labor market = cut. The USD weakened slightly, and USTs saw a bull steepening as the markets interpreted the press conference as less hawkish. However, equities experienced a downturn.

While Powell evidently isn’t satisfied with the current inflation situation, he seems to view inflation below 3% as not significantly deviating from the 2% target. He didn’t oppose a question hinting at a strategy of opportunistic disinflation akin to the 1990s, a concept previously suggested when advocating for no rate cuts earlier this year.

The policy direction is unfolding as anticipated in early 2024. There’s a suggestion to reconsider blind faith in central banks’ guidance post-pandemic, advocating for no rate cuts by the Fed (and consequently the RBI).

Relying solely on the Fed’s statements, which have been more volatile since the pandemic, could lead to investment strategy mistakes. This implies that drastic shifts (like rate hikes) may also require careful monitoring. The Fed’s rapid reversal from its March guidance on rate cuts in less than two weeks underscores this point. The potential misjudgment by policymakers regarding the transience or permanence of inflation post-Covid stems from macro models being based on past decade-long trends, while new structural changes are yet to be incorporated.

The absence of rate cuts by the Fed in 2024, followed by a shallow rate-cutting cycle, is becoming a reality as they struggle to achieve the final stretch of disinflation. This trend is affecting EM central banks, including the RBI. However, unless accompanied by immediate negative growth shocks, we don’t anticipate a collapse in EM risk assets and believe that a selective investment approach will fare relatively well for Indian assets.

Nevertheless, it’s important to recognize that significant divergence from Asia in both FX and rates may not be beneficial or desired by Indian policymakers, especially given the changing geopolitical landscape and economic models worldwide, necessitating agility from India as well.