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Mr Market and the government walked into a bar. What happened will be clear by the end of this newsletter.
This week’s highlight was the US Federal Reserve’s decision on policy rates and the surrounding commentary. The outcome was on expected lines, but had unexpected messages. To put it simply, when you walk into a bar, you expect to be served with your drink of choice and you also expect a light mood lift once you partake of it.
That is all there was to read in the reaction of the markets to the Fed’s interest rate cut. The key question always in a bar is how long the drinks will keep coming. From rational customers who prefer to avoid the following morning hangover to irrational ones that just want the flow to be unlimited, there are many.
But no one stops at one drink. Ergo, it is naïve to expect investors to not demand more rate cuts from the Fed and even more naïve to expect the government holding an unmanageable pile of debt to not force the Fed to cut rates.
While this may straddle the topics of both economic integrity and institutional independence, history is rife with attempts—both subtle and overt—of governments demanding easier monetary policy from their respective central banks. What matters is how the central bank reacts to these demands and that falls squarely on the extent of institutional independence, which is worrisome in America right now.
That said, economic integrity is more important, and the Fed must be competent in its assessment, timing, and communication of the policy. The Fed must be the good bartender who knows what to serve whom, when to serve and how much to serve. This brings us to the minefield of forecasts that are usually proved wrong by the actual data. There are as many forecasting errors as there are economists and central bankers are not immune to them either. Recall that the Fed had disastrously assessed inflation pressures to be transient in the past when data eventually showed it to be entrenched. Is the Fed being myopic again? Today’s Unhedged by the Financial Times, free to read for Moneycontrol Pro subscribers, questions Fed chair Powell’s assessment of disinflation in services.
Meanwhile, the Fed’s dot plots are curiously showing a wide range of forecasts among FOMC members. While there is precedent to this, if FOMC members stray away from each other on expectations, where does that leave the markets prone to wild guesses on any day?
For now, markets expect two more rate cuts by the Fed that will bring the Fed funds rate down by 50 basis points and fire up returns, especially on emerging market equities. Every time the bartender decides to be friendly, Mr Market at the bar is ready to pick up the tab for other tables. That means, foreign investors would take a warmer look towards Indian equities. Ananya Roy explains what could happen in her piece here now that the Fed has cut rates. Perhaps, the Reserve Bank of India (RBI) may feel freer to cut policy rates here. Considering that the Fed isn’t perfect, Powell’s guarded comments didn’t give away much and FOMC appears more fractured in its view than before, so markets must brace for volatility. Indeed, conflicting signals are making it difficult for foreign investors to decide on whether to buy or sell Indian bonds as our Chart of the Day shows. Perhaps foreign investors may turn buyers from net sellers in equities as well.
The upshot is: Markets want another high, another shot. But markets are seldom rational in their wants.
Miscalculating how much tequila is needed should not be on the bartender’s to-do list. Then, there is the government as well. Allowing an easy monetary policy along with a fiscal policy that appears to be easy as well is a recipe for future inflation. Running a tab for the government is disastrous. We started off with Mr Market and the government walking into the bar with a clear focus to indulge.
What happens depends on the bartender. One too many tequila shots do not have a happy ending.
Investing insights from our research team
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Global regulations are forcing Indian companies to rethink third-party risk
Modi’s belated visit to Manipur gave hope. It now needs to be followed by action
India Inc’s financial metrics are world-class. Leverage it to dominate global markets
India and the WTO Investment Facilitation Agreement: Beyond misleading headlines
India's Corporate Financing Shift: From bank loans to bonds
Making India a Global Sporting Power: A vision for excellence and manufacturing growth
Context Engineering: The next IT services frontier
Conversions Back in Focus: Kerala debate rekindles a national question
Tech and Startups
Technical Picks: HUDCO, LAURUSLABS, DCAL, AUROPHARMA
Aparna Iyer
Moneycontrol Pro
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