The US Federal Reserve (Fed) rate, or federal funds rate, is the interest rate at which banks lend to each other overnight. This rate significantly impacts global markets by influencing borrowing costs, investment decisions, and consumer spending. A higher Fed rate strengthens the US Dollar, attracts global investors to US assets, and raises the cost of borrowing.
In contrast, a lower rate stimulates borrowing and spending, boosting economic activity. Global markets react quickly to Fed decisions, as they affect inflation, currency values, and stock prices worldwide, given the US economy’s size and influence on global trade, investments, and capital flows.
US Fed Pauses Rate Cut Decision
The US Federal Reserve recently decided to pause further rate cuts, keeping the benchmark interest rates unchanged at 4.25 – 4.50 percent. This decision follows a two-day Federal Open Market Committee (FOMC) meeting and reflects the Fed’s cautious approach to balancing inflation control and economic growth. By maintaining current rates, the Fed signals that it is closely monitoring economic conditions and will adjust policy if necessary to maintain market stability. The decision was broadly in line with Wall Street expectations. This pause indicates the Fed’s strategy to carefully assess economic data and take measured actions to ensure sustainable growth while managing inflation risks in the economy.
Implications of US Fed Rate Decision on India
The decision to pause rate cuts in the US could lead to foreign institutional investors (FIIs) pulling money out of India and shifting it to US sovereign bonds, as they offer higher returns. US bonds become more attractive because of the higher interest rates, offering more security and returns compared to Indian equities or debt. As a result, these investors will sell their Indian holdings, moving capital into the US where returns are assured.
Risk of Rupee Devaluation
This shift is compounded by the risk of currency devaluation in India. The Indian Rupee is expected to weaken further against the US Dollar, making dollar-denominated assets even more appealing. In turn, this will put pressure on the Indian market, making it harder for companies to raise capital, while pushing the Rupee lower, leading to inflationary pressure in India. This movement could create a volatile investment environment, reducing the attractiveness of emerging markets like India in the short term.
Impact of Higher Fed Rates on Liquidity and Inflation
When the US Federal Reserve raises interest rates, the yield on US sovereign bonds increases, attracting more investors seeking safer, higher returns. This increased demand for US bonds draws capital away from riskier assets and investments in the US economy.
As a result, liquidity in the US economy decreases because less money is circulating in the market, leading to lower consumer spending and business investment.
With less money in circulation, inflationary pressures are reduced, as there is less demand for goods and services, helping stabilize prices. Over time, this process helps cool down the US economy, making it less prone to overheating and inflation.
The broader global impact is significant as well. Since most international trade is conducted in US Dollars, a stable and controlled US economy benefits the global trading system.
Written By: Dipangshu Kundu
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