Fed rate cut boosts sentiment, yet India’s policy and rupee to stay domestically driven

Forward guidance, reflected in the dot plot—a chart showing each member’s forecast for the path of interest rates—suggests that in 2026, the federal funds rate may be cut by another 25 basis points. The interest rate futures market signals that the next cut could come in the second half of the year.

Fed Chair Powell emphasized in his press conference that the current rate is within the broad range of its neutral value of 3%. The incoming Fed Chair is expected to be more sympathetic to the US administration’s preference for lower rates, which could influence the future trajectory of policy.

Data on US labour markets, economic growth, and core Personal Consumption Expenditures (PCE) inflation will continue to guide expectations around the FOMC’s potential rate cuts next year. Overall, forward guidance suggests that the US easing cycle may be approaching its end, in line with trends among other major central banks.

For India, the impact is mainly through portfolio capital flows into domestic assets, which influence the exchange rate of the Indian rupee. Exchange rate movements, in turn, can affect domestic monetary policy, particularly if changes in US policy trigger large capital inflows or outflows. For instance, during the 2013 “Taper Tantrum,” sharp rupee depreciation from May to August prompted the Reserve Bank of India (RBI) to raise interest rates aggressively to manage the twin deficits in the budget and current account.

Depreciation pressures on the rupee have increased in recent weeks, too, but the RBI’s response has been different. The Monetary Policy Committee reduced the repo rate last week in line with its inflation mandate, while raising its growth forecast. Improved external fundamentals, including manageable external financing requirements, sufficient foreign exchange reserves, and greater exchange rate flexibility, have enabled domestic policy to focus on local growth and inflation. This offers a degree of decoupling from the US monetary policy cycle, unlike in 2013.

While the futures market still prices in two more US Federal Reserve rate cuts in 2026, the US dollar may not face sustained depreciation in the near term. The Fed’s liquidity boost should support risk sentiment, which could encourage capital inflows into emerging market assets.

In India, domestic economic conditions will continue to guide monetary policy, but supportive global financial conditions will help transmit policy signals through financial markets. A sustained pick-up in portfolio capital inflows could reduce the RBI’s need to intervene in the rupee through dollar sales and ease liquidity pressures in the banking system.

However, US trade policy remains a larger influence. The International Monetary Fund’s (IMF) baseline growth estimates suggest that higher US tariffs could reduce India’s real GDP growth by 0.4% this fiscal year and by 0.3% next year.

Thus, while lower US interest rates provide a supportive global backdrop for capital flows, it is a combination of reduced US tariffs and resilient domestic growth that will ultimately drive foreign portfolio inflows into India and help support the rupee.

The author is chief economist, IndusInd Bank Ltd. Views expressed are personal.