All eyes on Fed's dot plot and inflation guidance, says Nuvama's Kapil Gupta

Markets are eagerly waiting for the Fed's updated dot plot for 2025, due later today.

With markets expecting a 25 basis point rate cut, Kapil Gupta, Executive Director of Research at Nuvama Institutional Equities, will keep his eyes glued to the Fed's revised dot plot and its inflation forecasts for 2025 in the central bank's December policy announcement. Going with the consensus, he also anticipates a likely slowdown in rate cuts in 2025 as inflation stays stubborn.

As for India's policy response, Gupta hinted in an exclusive interview with Moneycontrol that the Fed’s actions, as well as the dollar’s strength, will influence the RBI’s decisions. Despite that, he believes the dollar’s strength may subside, providing room for the RBI to cut rates in February.

Edited excerpts from the interview:

With the Fed’s upcoming policy decision, what key factors are you looking out for in the Fed's forecast or Powell's commentary later tonight?

The consensus is that the Fed will implement a 25 basis point rate cut, but we will be focusing on two things. First, the forward-looking dot plot, which shows how the Fed sees future rate changes. Second, the commentary during the press conference, especially regarding inflation. Both core and headline inflation have been quite sticky over the last few readings, so we’ll be paying attention to whether the Fed views this as a temporary issue or a persistent one.

Given the sticky inflation data this year, do you expect a change in the Fed’s outlook on rate cuts for 2025?

Yes, there has been a lot of stickiness in the inflation data. At the start of 2024, markets were expecting six or seven rate cuts, but this shifted throughout the year. Now, the consensus is around three to four cuts, with a shallower rate cut cycle expected due to persistent inflation.

Back in September, when the previous dot plot was released, there were initial concerns about a slowdown, which led the Fed to implement a 50 basis point cut in one go. The dot plot was also forecasting additional rate cuts through 2025. However, looking at the futures markets, the current Fed rate stands at 4.75 percent, and if it drops to 4.5 percent after the December cut, the markets are pricing in another 50 basis point cut for 2025. This suggests a range of 50 to 75 basis points, while the dot plot indicates a slightly more aggressive path. I believe the Fed will likely adjust its forecast to align with market expectations.

How do you think the Fed’s rate cut trajectory will impact Reserve Bank of India's (RBI) policy?

The Fed’s actions, as well as the dollar's movement, will certainly influence the RBI’s decision-making. The dollar has strengthened recently, but I believe the bulk of the dollar’s strength has already occurred. By February, when the RBI meets, we should have more clarity on the dollar’s direction, as well as the Fed's future path. Personally, my take is that the dollar’s uptrend will subside. That said, I'm not expecting a big weakness in the dollar either because the ECB and others need to cut rates faster compared to the Fed.

So, I think by February, some room can open up for the RBI to cut rates if it wants, purely from the dollar and Fed standpoint.

With concerns over a consumption slowdown, do you think domestic factors could influence the RBI to cut rates?

Yes, domestic factors could definitely play a role. The consumption slowdown, particularly in urban areas, and easing inflation are potential reasons for the RBI to start cutting rates, starting in February. However, the risk remains that external factors, like a prolonged trade war or currency volatility, could disrupt this outlook. Overall, I expect a gradual rate easing cycle, but it will depend on both domestic and global conditions.

Do you see the current strength of the dollar as the new normal, given the potential for a pro-America US government and ongoing trade tensions?

The dollar’s strength could persist if US policies, particularly tariffs, escalate further, especially if President Trump follows through on his rhetoric. If it remains just talk and less action, much of it is already priced into the dollar. So, the key factor here is the potential escalation of tariffs. If tensions increase to the point where China might respond with currency devaluation or similar measures, I believe the dollar will likely strengthen further.

Also, if the tariffs turn from a bilateral to a multilateral trade war, meaning four or five other countries also start to bear the brunt of tariffs, it could put further pressure on global currencies, including the Indian rupee. A multilateral trade war would also prompt a response from China, potentially adding more volatility to the markets.

Speaking of the rupee, we’ve seen it hit record lows recently. How do you think potential tariffs and geopolitical tensions might impact the rupee further?

The rupee’s performance will be influenced by two main factors: India’s trade deficit and the strength of the dollar. The trade deficit has been elevated recently due to gold imports, but we expect that to normalize. The dollar has strengthened because of the Fed’s policy and the US economy, but if tariff escalations expand to more countries, it could put additional pressure on the rupee. The biggest variable will be whether the trade war turns multilateral, as that would create more instability in the markets.