US Fed Holds Rates Steady but Signals Possible Hikes; Impact on Indian Markets

The US Federal Reserve's Federal Open Market Committee (FOMC) kept its benchmark interest rate unchanged at 3.50-3.75% during its latest meeting, marking the fourth consecutive hold. However, the central bank's updated projections and commentary suggest a shift towards a more hawkish stance, indicating the possibility of rate increases later this year.

New Fed Chair Kevin Warsh, presiding over his first policy meeting, announced several changes, including the discontinuation of forward guidance on inflation and growth. Warsh described the new policy statement as 'a bit shorter, a bit simpler,' noting that forward guidance was 'not well-suited to the current policy conjuncture.' The statement also omitted the individual voting breakdown of committee members.

The updated Summary of Economic Projections (SEP) showed a median estimate for the federal funds rate rising to 3.8% by end-2026, up from 3.4% in March. Of the 18 officials who submitted projections, nine forecast at least one rate hike this year, with six expecting multiple increases. In contrast, the March SEP had a majority expecting at least one rate cut in 2026, but only one official now holds that view.

This hawkish shift comes amid robust US economic data. Retail inflation accelerated to 4.2% in May, crossing the 4% threshold for the first time in three years and well above the Fed's 2% target. Meanwhile, non-farm payrolls increased for the third consecutive month, and the unemployment rate remained steady, signaling a strong economy. The ongoing war in West Asia has contributed to higher fuel prices and supply chain disruptions, adding to inflationary pressures.

Following the announcement, yields on short-term US Treasury notes rose to a 16-month high. According to Reuters, rate markets now assign a 72% probability of a rate hike by October. Higher yields reflect expectations of increased borrowing costs for the government.

For Indian markets, higher US interest rates could lead to foreign capital outflows, as US Treasuries become more attractive relative to Indian assets. Foreign institutional investors have already withdrawn $26.7 billion from Indian capital markets in 2026, exceeding the $11.84 billion pulled out in all of 2025. Key factors include high crude oil prices, geopolitical uncertainty, a weaker rupee, and the Indian market's underperformance due to limited exposure to AI-driven sectors.

Future foreign inflows may depend on a potential peace deal between the US and Iran, scheduled to be signed on Friday. Crude oil prices, which peaked at $125 per barrel during the conflict, have significantly impacted Indian markets. The rupee opened lower against the dollar on Thursday following the Fed's announcement.