The Federal Reserve’s December meeting marked a pivotal shift in the global financial landscape, triggering sharp reactions across international markets. While the expected 25-basis point reduction in the Federal Funds rate and a reduction in the Fed’s treasury and securities holdings aligned with forecasts, the real surprise came from Chairman Jerome Powell’s hawkish commentary. Powell’s remarks signaled a shift in monetary policy that could have significant ramifications, particularly for emerging economies already grappling with inflationary pressures.
The Federal Reserve’s decision to ease rates in its current cycle since September has been a central factor in market expectations, but Powell made it clear that the pace of future cuts will slow down. In his statement, he expressed concerns about inflation “moving sideways,” underscoring the need for caution. Powell further hinted that the current cycle of rate reductions might be nearing its end, with the central bank projecting only two more 25-basis point cuts in 2025, a sharp revision from the four cuts expected in September. This shift marks a pivotal moment, as it signals that future rate cuts will be contingent on economic data and evolving outlooks regarding inflation, employment, and growth.
This cautious stance from the Fed has raised concerns among investors, who are now bracing for the prospect of elevated interest rates well into 2026. The prospect of a prolonged period of high rates represents the end of the ultra-low interest rate environment that has prevailed since the 2008 global financial crisis. The terminal rate, which the Fed projects at 3 percent over the long term, marks a fundamental shift in the economic landscape. This new reality is likely to prompt market participants to reassess their positions in equities, commodities, cryptocurrencies, and other asset classes, potentially leading to heightened volatility.
While the Fed’s move might unsettle financial markets, there are rational underpinnings for the policy shift. The US economy remains resilient, with robust growth figures and a cooling job market, suggesting that a slower pace of rate cuts is appropriate. However, inflation remains a challenge, with November’s Personal Consumption Expenditure (PCE) inflation reading at 2.5 percent and core PCE rising to 2.8 percent. The Fed’s long-term target of 2 percent remains elusive, and the potential for increased inflation could become even more pronounced with the upcoming changes in import tariffs.
The threat of inflation is not confined to the US alone. As the new US administration under President Donald Trump is expected to ramp up tariffs in January 2025, global inflationary pressures could intensify. Countries like India may face retaliatory measures, further fueling inflationary trends. The likelihood of a sharp depreciation in emerging market currencies against the dollar adds another layer of concern, particularly for nations already battling currency volatility. While the Indian rupee has depreciated less than other emerging market currencies in 2024, the Reserve Bank of India (RBI) has had to dip into its foreign exchange reserves to curb market instability.
In this context, the RBI’s recent decision to refrain from cutting rates this month appears to have missed a key opportunity. With global headwinds expected to intensify in the New Year, the RBI will need to carefully navigate a complex landscape of rising inflation, currency depreciation, and shifting monetary policies from the US.
