“We do not wait for the house to catch fire and then act. Prudence at all times should be the guiding philosophy, both for the regulators and the regulated entities,” that was the view from RBI Governor Shaktikanta Das last week after announcing the monetary policy.

However, his counterparts in the US appear to be taking a contrasting approach.

With both US bond and equity markets consistently ahead of the Fed in discounting prospects of rate cuts in 2024, the monetary policy and post meeting press conference by Fed Chairman Jerome Powell was probably the last opportunity to push back against market expectations. But that did not happen, and markets finally got what they had been betting on (but proven wrong every time earlier) since the Fed started rising interest rates in early 2022 – a ‘Fed Pivot.’

Two possibilities

It was a broadly dovish press conference from Jerome Powell and the Fed dot plot indicated three rate cuts versus one rate cut in the September dot plot.  

With markets already factoring three cuts prior to the meeting, it has now moved on to factoring at least five rate cuts next year. That the Fed chose not to push back on markets running ahead of Fed actions, throws out two possibilities. Either they are confident of a soft landing, but that may be a gamble as their credibility has been severely dented after their ‘inflation is transitory’ call, a call that economist and former Pimco CEO Mohamed El-Erian termed as the worst inflation call in the history of the Federal Reserve (established in 1913).

If this gamble does not pay off as in Jerome Powell’s own words – ‘further evidence is required to build confidence that inflation is moving down sustainably towards our (their) goal’ any resurgence in inflation will dent their credibility irrevocably. This is what made Arthur Burns an infamous Fed Chairman in the 1970s when he pivoted early and inflation saw a resurgence.

The alternative case is that the Fed, while not openly admitting, is behind closed doors concerned that economy might be slowing down too fast rising probability of a recession next year.

Either ways, the Fed will be skating on thin ice till a decisive outcome makes things clear. Jerome Powell who wanted to repeat a Paul Volcker – famous for winning the inflation war in 1980s, will be holding his breath and hoping he does not end as Arthur Burns II.

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