Do it yourself

Given my view that the yield curve is no longer a strong leading indicator, I prefer to use a mix of indicators to assess the likely direction of the markets. Mortgage rates, credit growth, credit terms, repo outstandings and the size of the central bank’s balance sheet are the most prominent ingredients in the mix I like to use.

For example, in the context of the US, Mortgage rates are a close pulse on borrowing costs, consumer behavior, and economic health, less abstracted than the yield curve. In the U.S., the 30-year fixed mortgage rate tracks loosely with the 10-year Treasury yield—historically about 1.5 to 2 percentage points higher—but it’s more than just a derivative. It folds in lender risk appetite, housing market dynamics, and Fed policy fallout in a way that hits Main Street directly.

Presently, mortgage rates are climbing—30-year fixed is around 6.8%, up from 6.4% in late March, shadowing that recent 10-year yield jump to 4.5%. That’s despite recession odds rising, which, one may assume, would pull rates down as safety bets pile into bonds. Instead, it’s signaling stubborn inflation expectations (CPI still above 3%) and maybe some lender jitters about defaults if the economy wobbles. Post-2008, mortgage rates have also been a better tell on how QE and rate hikes filter through—when the Fed bought $2.5 trillion in mortgage-backed securities, rates stayed low even as Treasuries twitched. The curve didn’t catch that nuance.

Mortgage trends usually sidestep central bank distortion. The Fed can pivot Treasury yields, but mortgage rates reflect a messier mix—banks’ funding costs, housing supply, wage growth. In 2022, the curve inverted, but mortgage rates soared from 3% to 7% clearly indicating “tightening ahead”.

Mortgage rates provide a frontline view of credit conditions and consumer stress—80% of U.S. household debt is tied to mortgages—without the Fed’s thumb on the scale.

Credit growth, credit terms and repo outstandings pair well with mortgage rates to assess the genuineness of demand supply equilibrium of the credit market. Together, they cut through the noise of central bank meddling and give a clearer view of whether demand and supply are truly balancing or just riding artificial waves.

Credit growth is the engine’s RPM. It tells you how much new borrowing—household, corporate, or government—is fueling the system. In the U.S., total credit to the private sector grew at a sluggish 2.5% annualized rate in Q1 2025, down from 4% in 2023, as per Fed data. That’s tepid, especially with mortgage rates at 6.8% crimping home loans—mortgage debt growth is barely 1% year-over-year. Meanwhile, consumer credit (credit cards, auto loans) is up 5%, hinting that people are leaning on short-term debt as housing gets pricier. If credit growth stalls while mortgage rates rise, it’s a sign demand’s weakening—banks aren’t lending, or borrowers aren’t biting.

Credit terms are the fine print—how tight or loose lenders are with the purse strings. Are banks demanding higher credit scores, bigger down payments, or jacking up spreads on corporate loans? Right now, the Fed’s Senior Loan Officer Survey (Q4 2024) shows tightening standards on commercial loans—net 15% of banks raised hurdles—while mortgage terms eased slightly, with down payment requirements dipping to 10% on average from 12% in 2023. High-yield bond spreads are at 350 basis points over Treasuries, up from 300 in January, signaling risk aversion. If terms toughen as mortgage rates climb, it’s a red flag—supply’s there, but lenders don’t trust demand to hold up.

Repo outstandings are the plumbing’s pressure gauge. The repurchase market shows how much short-term cash banks and funds need, and how willing they are to leverage. As of April 2025, U.S. repo volumes are hovering at $2.8 trillion daily, per NY Fed data, up 10% from last year. In a “genuine” equilibrium, repo would hum along smoothly, not swell like this while credit growth lags.

Mortgage rates at 6.8% look less alarming if credit’s flowing, terms are loose, and repo’s calm—demand and supply are moving in tandem. But slow credit growth, tightening terms, and repo pressure say the market’s strained—supply’s there, but demand’s shaky, and liquidity is a crutch. Central banks can twist yields all they want; these metrics show what’s really moving.

Central bank’s (CB) balance sheet is another key watchable for me. If CB takes too much paper on its own balance sheet, it indicates an attempt to unfairly influence the bond market equilibrium.

CB’s balance sheet is a massive lever they can pull to sway markets, and when it swells too much, it’s a flashing sign they’re trying to muscle the bond market into line rather than letting it find its own footing. As of April 9, 2025, the Fed’s balance sheet sits at about $7 trillion, down from its $8.9 trillion peak in mid-2022 but still a hefty chunk—roughly 25% of U.S. GDP.

Fed loading up on paper—mostly Treasuries ($4.3 trillion) and mortgage-backed securities ($2.3 trillion) as of late 2024—is a deliberate play to augment liquidity or cap yields.

In a free market, bond yields would reflect investor sentiment—fear of inflation, growth bets, default risks. But when the Fed gobbles up $95 billion a month or steps in with “emergency QE” like some predict if Treasury markets seize up again, it definitely distorts the equilibrium.

I use the classical 2:1 debt equity parameter used to benchmark the corporate balance sheets, to assess the central bank’s balance sheet also. I think M2 (Money Supply or Central Bank’s liabilities) should not be more than 2x of the assets on its balance sheet.

For context, in the US M2 money supply is close to US$21 trillion, versus the Fed’s assets of US$7trillion. That is a 3:1 debt equity ratio for the Fed. This implies excess liquidity from years of bond-buying ($4.3 trillion Treasuries, $2.3 trillion MBS on the Fed’s books). Pre-GFC M2 to Fed balance sheet ratio reached 8:1. Banks were churning out loans—subprime mortgages, leveraged buyouts, etc. —while the Fed’s balance sheet stayed lean, mostly short-term Treasuries. Reserves were minimal ($10 billion or so), and the fractional reserve system let M2 balloon. When the housing bubble popped, that 8:1 leverage meant there was no cushion—credit froze, banks choked, and the GFC happened.

(i)    Bond markets are usually more correlated with the economy.

(ii)   Size of bond markets is materially larger than the equity, currency and commodity markets. It has the largest number of leveraged positions at any given point in time; and most of the large and influential market participants are more active in bond markets as compared to the other markets.

I am however inclined to disregard this piece of conventional wisdom. In my view, it would make sense only if the markets are operating in a free and fair manner. In cases where the central bankers and governments (through Sovereign Wealth Funds and other institutions controlled by it) actively and frequently intervene in the market, effectiveness of bond markets in leading the markets is impaired.

The world has definitely changed after the global financial crisis (GFC 2008-09). Central bankers, government, and public institutions are now playing significantly more active roles in the financial and commodity (especially gold and energy) markets. Bond prices are often influenced to suit the objectives of fiscal policy. Stock prices are influenced to suit political expediency.

Even pre-GFC, equity and bond traders did look at proxies like USD/CHF or copper—known as "Dr. Copper" for its economic sensitivity—for directional cues. In the past one decade we have seen Japan’s central bank buying equities; India’s government nudging markets via state-owned entities like LIC; the US Fed’s quantitative easing indirectly supporting massive amounts of stock buybacks; and Sovereign wealth funds in the Gulf Cooperation Council (GCC) countries piling into equities. This clearly indicates that in markets "no fixed formula works forever." Markets are adaptive. What held true for the past 35 years might not hold for the next 35.

US Bond yields no longer a lead indicator

In my view, the yield curve is fully relevant only if the market is free and genuine demand supply equilibrium of bond prices is discovered by the market forces. In situations where central bankers direct, manipulate or regulate yields, the yield curve is materially less important.

There is plenty of recent evidence, pointing that the US bond yields are no longer a strong indicator of the economy and/or markets. For example, consider the case of the US yield curve inversion in 2022-23.

Typically, an inverted yield curve—where short-term Treasury yields exceed long-term ones—has been a reliable harbinger of recession, preceding every U.S. downturn since the 1950s with a lag of roughly 6 to 18 months. The inversion that began in July 2022, peaking in mid-2023 with the 10-year/2-year spread hitting around -100 basis points, was the longest on record, lasting over two years. By historical standards, a recession should’ve hit by mid-to-late 2024. However, it has not happened; and the GDP growth held steady at 2.8% annualized in Q4 2024, and unemployment remains low at 4.1% as of March 2025.

Moreover, after un-inverting in September 2024—when the 2-year yield (around 3.6%) briefly dipped below the 10-year (around 3.8%)—yields have climbed across the board in the last two weeks. This morning, the 10-year yield is hovering near 4.5%, up from 4.0% in late March, while the 2-year has risen from 4.1% to about 4.5%. Incidentally, this rise coincides with a spike in recession odds, with the New York Fed’s yield curve model pegging the probability of a recession by mid-2026 at around 40%, up sharply from 25% a month ago. Normally, you’d expect yields to fall as recession fears mount, reflecting a flight to safety and anticipation of Fed rate cuts.

Prima facie, it appears that the bond market is more concerned about the rising inflationary expectations, particularly in light of the latest tariff policy of the US government. CPI is currently running above 3%—and there is skepticism about the Fed’s willingness to cut rates meaningfully from their current 4.75%-5.0% range. Higher yields also reflect a demand for more compensation amid uncertainty which could stoke inflation further. Arguably, the economy’s resilience—strong consumer spending, a robust labor market—may have also impaired the yield curve’s predictive edge this time. Structural shifts, like massive Fed balance sheet expansion since 2008 or global demand for long-term Treasuries, have certainly distorted its signal.

The recent yield rise despite recession odds implies that bond traders are betting on tighter policy or inflation risks, despite economic data flashing slowdown warnings (e.g., manufacturing PMI below 50 for months).

Conclusion: The yield curve’s relevance erodes when it’s less about market discovery and more about central bank glide path. Though it’s still worth watching, it’s no longer the king it once was in a freer market.

Tomorrow I will share my thoughts of what could be a better indicator, or aa mix of indicators to assess the likely market direction.

In a post meeting press interaction, Fed Chairman Jerome Powell noted that “The unemployment rate has stabilized at a low level in recent months, labor market conditions remain solid, and Inflation remains somewhat elevated.” He further added that the Fed needs to see “real progress on inflation or some weakness in the labor market before we consider making adjustments.”

Most notably, he emphasized that we're meaningfully above the ‘neutral rate’. He said, “I have no illusion that anyone knows precisely how much that is and but having cut 100 basis points means that it's appropriate that we not be in a hurry to make further adjustments.” (‘Neutral rate’ is a fed rate that is considered neither stimulative nor restrictive of growth under the current circumstances.)

Higher for longer: The market participants have taken this to imply that the current rate cut cycle is certainly not over and may resume after a pause, as the Fed gathers more evidence on inflation. Nonetheless, analysts now appear less sanguine about the lower bound of the present rate cut cycle. The consensus amongst them is emerging that the long-term bottom rate may have risen to 3% from the earlier estimates 2.5%. The ‘Fed pause’ is also being influenced by uncertainties surrounding the new administration's direction - on fiscal, trade, and government spending matters. The Fed officials noted “they don't intend to react until policies reach the implementation stage and begin to impact incoming economic data”.

Markets: Post the Fed decision, stock prices ended lower (S&P500 -0.5%), USD marginally stronger (DXY +0.2%) and benchmark bonds stronger (US 10yr Yield -0.37%).

RBI: The ‘Fed pause’ has made the February 06^th rate cut by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), less certain. There are however more chances that RBI may change its stance to ‘accommodative’ from ‘withdrawal of accommodation’, signaling now growth is a priority over inflation.

Noting the economic conditions, especially still elevated inflationary expectations and resilient growth, the Fed indicated that 2025 may see fewer cuts than the previously estimated number. “With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” Chair Jerome Powell said at his post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”

The FOMC raised its projection for full-year 2024 GDP growth to 2.5%, from 2% in September. However, in the following years, the FOMC officials expect GDP to slow down to its long-term projection of 1.8%. The committee lowered its expected unemployment rate in 2024 to 4.2%, while headline and core inflation were pushed higher to 2.4% and 2.8% respectively, slightly higher than the September estimate and above the Fed’s 2% goal.

The resilient growth and elevated inflationary expectations would require the Fed to hike or hold rates in 2025. However, officials appear wary of keeping rates too high and risking an unnecessary slowdown in the economy.

Insofar as the Trump 2.0 policies and their impact on the growth are concerned, the Fed Chairman Jerome Powell prefers a wait and watch approach. IN the post FOMC meet press interaction he said, “We’re just not at that stage.” He further added, “We need to take our time, not rush and make a very careful assessment, but only when we’ve actually seen what the policies are and how they’ve been implemented.”

The financial markets reacted negatively to the FOMC decision. Dow Jones lost 1123 (2.58%). Falling for the tenth consecutive day, it has recorded its worst losing streak since an 11-day slide in 1974. The S&P500 (-2.95%) and Nasdaq Composite (-3.56%) fell even more. The benchmark 10-year treasury yields jumped 3.08% to 4.52%, the highest level since April 2024 and 90bps higher than their August 2024 lows. UST Index rose 1.2% to its highest level in almost three years. Gold prices fell 2.3%, taking the yellow metal below US$2600 level after 3 months.

Myth of free market

A fundamental principle of economics is that “in a ‘free market’ current price of anything having an economic value is a function of demand and supply of such things at that particular point in time.” Of course, there could be multiple factors that may impact the demand and supply of a thing; but usually nothing impacts the “price” directly other than the forces of demand and supply.

In a ‘controlled and/or manipulated market’ the prices of things are fixed by the controlling authorities (or forces); regardless of the demand and supply for such things. In such markets, usually demand and supply of things are controlled and/or manipulated; or demand and supply duly get adjusted to the fixed/manipulated prices.

In the modern world, money is arguably the largest factor of production in the world. The price of money (interest rate) should ideally be a function of demand and supply of money. In case of excess supply, the interest rates should be lower and vice versa.

If we apply this core principle of economics to the world around us, we may discover that a significantly large part of global markets is presently either controlled or manipulated. The free market may only be prevalent in textbooks now. It has been completely obliterated from the political speeches across the world; and is also being systematically removed from the policy documents.

The US Federal Reserve can simply manipulate the supply of the USD to influence the prices of bonds, goods & services denominated and settled in USD. An axis led by China and Russia is emerging to weaken the powers of the US to manipulate the global markets through controlling supply of USD. So far, it is more of an intention. There is no work-in-progress evident on the ground.

Removing all doubts

Notwithstanding all the grandstanding, global preaching, and progressive narratives, the US has mostly been a racist and sexist society. For many decades there was a pretense on part of the US politicians to present it as an inclusive, liberal and free society. In the ongoing elections the pretense has been shed. There is a conspicuous effort to make the contest between a Right wing, “white” supremacist “man” and a “woman who happens to be “black”.

Confidence of RBI

In its latest monetary policy report, the RBI has expressed strong confidence in the Indian economy. It projected the real GDP growth of 7.2% for FY25. It also sees the growth momentum sustaining in FY26 with 1QFY26 of 7.3%.

On the other hand, the brokerages are projecting material slowdown in profitability growth. The corporate tax collections for FY25, so far, are down 6% yoy. The core sector growth has collapsed to many months low in August. The capital expenditure of the states in FY25 is projected to be less than even FY23. The central government spending which has supported the growth since FY21 is also tapering. Private capex has picked up but is mostly related to asset (land and building) acquisition rather than enhancing productive capabilities.

I wonder where the confidence of the RBI is flowing from! Is RBI relying too much on the forward looking surveys indicating better business and consumer confidence for the future despite conspicuous deterioration in the current conditions? Or is there something not known to the markets; just like Haryana election results where CM Saini could clearly see what no one else saw.

INR, yields and rate cuts

RBI has apparently let go of the USDINR 84 level, which it was allegedly defending for almost a year. The FPI outflows are accelerating every week. The US0 India yield gap is narrowing, further raising the specter of accelerated outflows.

The benchmark US yields (now 4.10% rising 40bps after aggressive 50bps rate cut by the US Fed) and mortgage rate (now over 8%) have not behaved on the expected lines.

In India also there is almost a consensus over a repo rate cut in December. The MPC members might however be wondering whether it is desirable to waste one important arrow in their quiver at this point in time when there are ample indications of a crisis like situation emerging in 2025, requiring aggressive policy support. Given the market condition, a rate cut may not be passed on the borrowers as banks are already struggling with credit-deposit growth mismatch. The benchmark yields have already eased in anticipation of a cut and may not ease much post the cut. In any case, the RBI may not like the US-India yield spreads to narrow further, further pressurizing USDINR.

I find many events, besides rate cuts and elections, that are occurring on the sidelines that need to be noted by the investors. Considered individually, these events may not look like triggering a meaningful move in global markets. However, if we take a collective cognizance of these events, the probability of global market shock would certainly rise by a few points.

The following events, for example, have drawn my attention in the recent months.

Central banks loading on gold

Post the global financial crisis 2008-2009, the central banks have significantly increased their gold accumulation. In 2023, central banks added 1,037 tonnes of gold – the second highest annual purchase in history – following a record high of 1,082 tonnes in 2022. The trend is continuing in 2024 also. (see here)

The notable thing in this trend is the sharp rise in gold accumulation by the Russian and Chinese central banks. President Xi and President Putin, along with Iran and North Korea (CRIK) are seen as an informal anti-NATO alliance. (see here)

Biden provides fresh impetus to the Sino-US tariff war

The Biden administration has provided significant impetus to the Sino-US tariff war started by the Trump administration. Despite strong objections from the domestic industry, the US has not only retained the tariffs imposed on the Chinese imports by the Trump administration in 2018, but made some material additions to the list. The new tariff list includes a 100% duty on Chinese EVs, 50% on solar cells and 25% on steel, aluminum, EV batteries and key minerals.

Besides, the Biden administration announced new measures aimed at Chinese e-commerce platforms to minimize the low-value imports eligible for duty and tax exemptions. (See here)

Putin mediating thaw between India and China

The rhetorical aggression between China and India has decelerated materially in the recent weeks. It is reported that China is retracing from its advanced positions in the Indian territories and willing to disengage completely. Apparently, it has occurred after the recent visit of PM Modi to Russia and Ukraine. (see here) This is obviously an important geopolitical development after the coup in Bangladesh, allegedly with support of the US. (see here)

Hedge Fund piling on short positions

In the past few weeks hedge funds have been piling on their short positions. They have now been net sellers for the five consecutive weeks, not a normal situation when the benchmark indices are making all-time highs.

Chinese economy imploding, govt puts a tight leash on investment professionals

All the recent data about the Chinese economy indicates that the Chinese economy is slowing much faster than previously estimated. As per the current estimates, China is most likely to miss even a modest 5% growth target. (see here) By all indications the Japanification of the Chinese economy is happening against the wishes of all. The Chinese economy has been the engine pulling the global economy in the past two decades. If this engine falters, it cannot be good news for the global economy and therefore markets.

The Chinese authorities have been taking action against the entrepreneurs, like Jack Ma of Alibaba, failing to adhere to the strict regulatory norms. Recently, the authorities cracked down on financiers – impounding passports of 8700 investment bankers and restricting their overseas travel. (see here)

This could be seen by some as a precursor to a massive shift in the economic development followed in the past two decades. (see here)

Traders incurring losses despite market rally

On 12^th September 2024 (weekly F&O expiry day), many option traders in India experienced exceptional losses due to sharp surge in the benchmark indices in the last hour of trading. It happened again last Friday. This has happened when sharp underperformance of the broader markets and popular stocks is already bothering the non-institutional (retail) investors. In the technical analysis parlance, these are conspicuous signs of a large-scale distribution taking place. Empirical evidence suggests that this phase of the market is usually followed by a dull period in the market, marked by poor returns.

It's still the month of September and on my morning walks, I can feel the chill in the air. This is not usual weather in Delhi NCR. I am getting the same sense in markets. If you are also feeling this chilling sensation, please do share your views.

No panic in the boardroom

Unlike the previous two rate cycles that started with a rather aggressive 50bps rate cut – first October 2008 post the Lehman collapse and second March 2020 post Covid-19 break out – this cut is apparently not a panic cut.

The Fed chairman sounded confident about growth and employment level. He emphasized that the central bank is not in a hurry to ease policy, as he sees no likelihood of an elevated downturn in the economy. He mentioned, “There’s nothing in the SEP (Summary of Economic Projections) that suggests the committee is in a rush to get this done.”

The Chairman categorically advised the markets to not take this 50bps cut as “new pace”. He said, “we’re going to go carefully meeting by meeting, and make our decisions as we go”.

The decision to cut was however not unanimous. In a rare dissent, one member (Michelle Bowman) voted for a 25bps. This could be seen as yet another sign of “no panic” in the Fed board room.

Committed to price stability without pain in labor market

Announcing a victory over inflation, Mr. Powell announced, “The U.S. economy is in good shape. It is growing at a solid pace. Inflation is coming down.”

As per the latest economic data release, the US GDP expanded at 3% annual rate in 2Q2024 with 4.2% unemployment rate (considered near full employment), and inflation at 2.2% in August 2024.

Outlining the latest policy objectives, he commented, “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation”. Guiding the markets, he emphasized that investors should take the Fed’s 50bps rate cut as a sign of its “strong commitment” toward achieving that goal.

Neutral rate seen close to 3%

The FOMC members see cuts of 25bps each in November and December FOMC meetings; 100bps cut in 2025 and 25bps cut in 2026 – implying that the latest easing cycle may end with the Fed rate range of 2.75-3.00%.

The Fed Chairman also mentioned in the post FOMC press meet that the neutral rate is likely significantly higher than it was on the previous occasions.

Markets ended lower

Markets – equity, bonds and commodities – ended the day with marginal cuts post the Fed announcement; while the USD was marginally stronger. This could be an outcome of either (i) sell on news; or (ii) traders’ disbelief in what Fed says about the strength of the economy.

What now

In my view, this aggressive 50bps cut is more of a correction than an aberration. Perhaps the Fed realized that they are running slightly behind the curve and hence tried to catch up. I do not see it as a panic move and would not like to indulge in “there is more to it than what meets the eye” debate.

Unlike 2008, there is no corporate balance sheet crisis, no risk of global markets freezing, and unlike 2020 there is no shutdown necessitating fiscal and monetary profligacy. It is a normal rate cycle change in response to a normalizing economic cycle. Therefore, expecting a market reaction like 2008 (sharply down) or 2020 (sharply higher) may not be appropriate.

I feel the US markets will adjust to the new policy trajectory in a couple of weeks and move accordingly. The lower rates shall help arrest the decline in the US housing markets and consumer spending. The bond yields may come down and the hedge trade in gold may begin to unwind. The corporate discretionary spend may also normalize as the cost of borrowing eases. This could be a relief for the Indian IT services companies.

For India, I am not sure if the RBI will rush to cut in October meeting, but would not rule it out completely. Financials and commodities are two sectors that need to be watched closely, in my view.

In the next couple of months, the markets in India will be driven by the 2QFY25 earnings. Any disappointment could lead to a decent correction in the markets. For now, I do not see a need to make any change in my investment strategy. (More on this next week)

The major risk to the markets comes from geopolitics now. The situation in the Middle East is worsening by the hour. NATO and CRIK (China, Russia, Iran and North Korea) alliances are hardening their positions, both on trade and war, making the situation explosive. (More on this next week)

These comments read with the minutes of the last meeting of the Federal Open Market Committee (FOMC) provide adequate ground to believe that—

(i)      The current rate cycle has peaked out; and the next policy move will be a rate cut.

(ii)     The policymakers are confident the spike in inflation that occurred in the aftermath of Covid-19 pandemic (massive cash stimulus fueling demand and logistic challenges causing break in global supply chains) has been successfully tamed.

(iii)   The economy is no longer overheated as the pandemic stimuli have been gradually withdrawn, the job market has cooled down, and commodity prices are behaving normally.

Though Mr. Powell did not make it clear that the FOMC will cut rate in the next meeting scheduled to be held on 17-18^h September 2024; the market consensus is assuming it to be a certainty. The debate is now circling around how aggressive the Fed could be in their pursuit of policy easing. Though, Mr. Powell emphasized that the rate cut will be data driven, a majority of market participants are expecting a 25bps cut each on 18^th September, 7^th November and 18 December. Some aggressive estimates are building 50bps cut each in September and December.

I am not competent to comment on the dynamics of the US monetary policy and its implications for the global economy and markets. My concern at this time is limited to how does the likely change in the Fed’s policy stance affects my tine portfolio of investments, if at all.

In this context I note that—

·            In its last meeting, the Monetary Policy Committee of the RBI retained its policy stance of withdrawal of accommodation and maintained the status quo on policy rates by a four to two majority vote.

One of the dissenting members, emphasized that “Global uncertainties continue. The Fed, in indicating a cut in its September meeting, pointed out that since monetary policy acts with a lag they can't afford to wait until they reach their inflation target before cutting. That lag may be responsible for the sharply adverse August jobs report that has stoked recession fears and created market volatility. That a series of small signals were ignored, may have led to a critical large one. Monetary policy needs to act well in time. Spillovers led the global manufacturing PMI into contraction zone in July at 49.7.” (See here)

The other dissenting member was even forceful in his dissent, stressing, “For the last several meetings, I have been expressing concerns about the unacceptable growth sacrifice induced by a monetary policy that is excessively restrictive. The majority of the MPC however do not share this concern, perhaps because they think that the Indian economy is already growing at close to its potential growth rate. I think that such a view reflects (a) an unwarranted pessimism about the growth potential of the economy and (b) an overly sanguine expectation about growth in ensuing quarters. I disagree with both prongs of this assessment.” (See here)

This clearly highlights that despite being warned of the perils of running behind the curve and impairing the growth potential, the MPC decided to retain its stance. Maybe the RBI is not as sanguine about the price stability and growth potential as some of the members of the MPC.

·            The fourteen-month gap (July 2023 to September 2024) between the Fed pause and the first cut would be the second longest in the past five decades. The markets have been anticipating a Fed rate cut for almost a year now.

In this period, the stock markets, both the US and the Indian, have not witnessed any meaningful correction and are already at an all time high level. The question is whether the anticipated rate cut would provide immediate impetus to the markets; or the markets will be worried about further deterioration in economic growth.

It is pertinent to note that empirical evidence suggests that in the past three rate cycles, the US market has fallen 12 to 50% during the Fed rate cuts.

·         The governments in the US and India are not in a position to back up the monetary policy easing with fiscal stimuli.

Under the circumstances, for now I am more inclined to assume that:

·         It is not certain that the RBI will immediately follow the US Fed in cutting rates, unless strong evidence of growth collapsing emerges. Rise in the yield differential may attract stronger flows and support USDINR and markets.

·         A weaker USD may support commodity prices

·         A panic cut by RBI on the other hand may adversely affect the margins of banks (loans get repriced immediately while deposits take longer; CD ratio faces further pressure); and also affect the overall sentiments.

·         The earnings momentum appears to have slowed down in 1QFY25. A sharp cut by RBI might arrest the slowdown in earnings momentum; and also help higher equity valuations to sustain.

·         Negative real rates may adversely affect savers (consumption) and support capex.

I will review my portfolio in accordance with these assumptions in the next review. For now, I am just staying put.