Emkay Global Financial Services

Emkay Global Financial Services

The Fed remained in a wait-and-watch mode yesterday, with rates on hold at 4.25-4.5%, frozen by what it described as ‘increasing but balanced risks of higher unemployment and higher inflation’. It, however, reiterated that policy is “well positioned†to wait for further clarity. The statement indicates that the FOMC is looking through the 1Q GDP contraction and still sees growth at the start of the year as “solid†.

Powell did not add much color to the presser beyond underscoring the balanced albeit increasing risks and the need to remain data dependent. Powell referred to “waiting†over 20 times. One notable is that despite risks being balanced, Powell did indicate a kind of ranking on dual mandates preferring inflation, by stating that “without price stability, we could not achieve the long periods of stronger labor market conditions†.

 This is neither a hawkish nor a dovish change – simply an acknowledgement of the stagflationary risks imparted by trade policy.

It appears that this classic supply-shock conundrum will keep the Fed on hold till there is a clearer sign of weakening in the labor market, implying that the summer could stay dry as far as the Fed’s additional easing is concerned. The next Fed move could be delayed till September.

In fact, Powell did not bite on the query about the June FOMC in his presser, though his tone indicated that staying on hold on this policy was an easy call for the Committee, thereby raising the bar to act as soon as next month. The OIS market is still pricing around three 25bp cuts in 2025.

Tactical easing to continue in rest of the world

 While the Fed grapples with at least a temporary rise in inflation due to tariffs, central banks across Europe (including EMs) and Asia are clearly in an easing mode. Among G-3, the ECB is at the forefront of this move and will diverge from the Fed by easing this quarter. China, on the other hand, has continued its easing bias.

Meanwhile, patchy global narrative on growth and tariff noise, and a generally weaker broad USD, has allowed EM central banks, including the RBI, to be less focused on the FX fight and enjoy some policy flexibility on rate settings in general.

We maintain we could see RBI’s terminal rate at 5.25% (+/-25bps) in this cycle, no doubt contingent on the extent of the global slowdown/recession. However, we are keeping a tab on fluid global dynamics and FX moves as well – both of which would be imperative inputs in the RBI’s reaction function. Besides, policy focus toward keeping liquidity in surplus and toward, or even higher than, 1% of NDTL should be seen as a de facto rate cut which could thus lead to reassessment of the depth of conventional rate cuts. We note that India has been the best-performer among key sovereign debt markets, with 10-year easing ~44bps CYTD vs 26-27bps in same-tenor USTs and +17-18bps in German Bund.