The US Fed and the dilemma of rate cuts

There is an interesting set up in the US markets. While the US Fed has reiterated its stand that it does indeed look to maintain its earlier view of lowering interest rates, there is increasing concern surrounding the level of the US government debt, continuing positive industrial data and the outlook for the economy. There is increasing concern if the US Fed will indeed go ahead with the 3 promised cuts this year. Analysts had predicted almost 6 rate cuts at the start of year when consensus pointed to a slowing down of the economy and the need to achieve a soft landing.

However, the economy has continued to remain strong on the back of a strong fiscal stimulus, and US government debt levels have become alarming. The US Fed finds itself in an especially conflicting situation. The cost of funding the debt has also become a matter of concern and inflation remains above expectation. We must look at the recent US Treasury issuances that have funded the fiscal boost, which has largely been through the issue of short-term securities. As a result, longer term treasury securities have rallied. But that is not a sustainable solution. Soon, the treasury will start to borrow long, and it could lead to higher yields on the longer end as well. While most expect the US dollar to weaken with rate cuts on the anvil, the leeway that the US Fed has looks very narrow now. The US dollar may also continue to remain strong as a result.

With the US elections around the corner, there are significantly more complex issues that will have an impact on India and Indian stock markets and that too remains a meaningful overhang for the local markets. Immigration has become a burning issue for the current elections and these policies are closely tied to the fortunes of the Indian IT companies, at least in the short term.