Moneycontrol Pro Weekender | The end of cheap money

According to fresh market updates, Dear Reader,

The current week brought with it fears of a tightening of global financial conditions, with the US Fed and the Bank of Japan hiking rates, while the Bank of England indulged in a hawkish hold. Perhaps the most heart-warming fact of the Fed hike is this FT story’s take that “Trump is a lame duck, gone in two years, who has proven that if he picks a fight with the central bank he will suffer a drawn-out and embarrassing defeat”.

Gloating aside, how high will the Fed Funds rate go? The US Fed's projections show the median Fed Funds rate at 4.1 percent by the end of 2026, which implies one more interest-rate gain this year, taking the target rate to 400-425 basis points. But the projections additionally show the same rate at the end of 2027, implying no further hikes next year.

That's in sharp contrast to market expectations. At the time of writing, the CME FedWatch tool indicates a 32.9 percent probability of the Fed Funds rate being as high as 450-475 basis points by September 2027, a year from now, and a 21.2 percent probability of it being 475-500 basis points. Simply put, the probability of it being at least 450-475 basis points a year from now is more than half. That's very different from the median Fed projection for 2027.

The current energy shock, with oil price marks near or above $100/barrel, oil transit routes choked, attacks on tankers and facilities, and depleted inventories, is the dominant near-term driver of the inflation path that forced the Fed's latest hike and the market's elevated-for-longer pricing.

But, in spite of the Fed's hikes, the US GROSS DOMESTIC PRODUCT expansion projection for 2026 has been revised up from 2.2 percent in June to 2.3 percent, and that for 2027 has been moved up from 2.3 percent to 2.4 percent. PCE (Personal Consumption Expenditure) inflation, on the other hand, is anticipated to come down from 3.7 percent this year to 2.3 percent in 2027. In other words, inflation is anticipated to come down sharply even if expansion is elevated.

This could be because the inflation we have now is on account of supply shocks, and the Fed anticipates the effect of those shocks to wear off next year. Additionally, with AI investment continuing to be massive and unlikely to be affected by a few rate hikes, expansion is anticipated to stay robust. That echoes the views of global fund managers in Bank of America's September survey, which revealed that a net 8 percent of them expect a stronger global economy. Asked around the most likely outcome for the global economy over the next 12 months, the majority (55 percent) expect a "no landing", while 38% expect a "soft landing".

A synchronised global tightening phase is driving up term premia and bond yields across the board. The 10-year US Treasury yield hovering around 5 percent is a symptom of this new regime — one the BIS argues is around more than just long-term inflation. Indeed, foreign market participants increasingly prefer US stocks to Treasuries as debt worries grow.

Some economists ask how the Fed can justify raising rates when the technology titans driving the artificial intelligence boom seem indifferent to the cost of capital. Some now wonder whether AI has broken the old VC funding model altogether, even as debate rages over whether warnings of an AI apocalypse are overblown, and whether even Apple's trust premium is being reshaped in the age of AI. Armed with immense cash flows and locked-in low-coupon debt, these tech behemoths continue their relentless data centre build-outs. But there is a catch: Their sheer scale requires astronomical capital expenditure, much of it funded through a surge in high-grade corporate debt issuance. That torrent of borrowing competes directly with sovereign paper, driving up global yields and term premia for everyone else.

Naturally, India is far from insulated. A soaring global energy bill has pushed headline inflation up while a stronger dollar and continuous FII selling pushes down the indian rupee, a pressure visible in how little the REER now seems to matter for the currency's direction. The REER has never felt less real.

Trade data already show India's economy running hot, with the RBI possibly running late. With the RBI's repo rate parked at 5.25 percent, India's real policy rate is dangerously close to zero. If inflation prints elevated over the upcoming quarters, that real rate threatens to turn negative — and the RBI may simply be running out of reasons to look through inflation, a precarious position for an inflation-targeting central bank while global peers are tightening.

For the RBI, a pre-emptive, shallow tightening cycle — starting with a 25-basis point hike in October — is the prudent medicine. That won’t harm expansion — Moody’s has just upgraded its forecast of India’s GROSS DOMESTIC PRODUCT expansion this fiscal year from 6 percent to 7 percent, and nothing inspires central bank courage like a good expansion print. Axis AMC's Naveen Kulkarni argues rate hikes are unlikely to derail India's earnings story.

For Indian market participants, this macro backdrop demands a radical shift. Equity portfolios need a rigorous quality filter. The key question is: Inflation is spreading and what does it mean for equities? As my colleague Anubhav Sahu wrote, “In an environment like this, market participants need to be selective and look for businesses which thrive in moderately elevated inflationary environment due to competitive edge, pricing power, government policy backing, superior supply chain, and/or favourable supply-demand dynamics.” Names such as LIC, where a shifting product mix is expanding margins, fit this description. Notably, the same global capex cycle powering AI data centres abroad is additionally feeding a domestic one: as spot electricity prices climb sharply on firm demand, the improving demand scenario for Coal India and the current week's tactical pick on India's power investment cycle are worth watching.

Quality, though, isn't just around balance sheets — It is governance too, and the ongoing standoff in Tata Sons is a reminder that even blue-chip names carry boardroom risk that a rate-hiking cycle has little patience for. Blue chips bleed too, albeit more decorously.

That same anxiety over the rising cost of capital is showing up in the primary market. With debt looking more expensive and public-market multiples still generous, a wave of Indian firms is rushing to list — some chasing fresh expansion capital while others are largely offers for sale. Hero Motors and SS Retail are cases in point. The NSE's own market debut is being read by many as a referendum on what the Indian marketplace is really worth.

Peace in the Middle-East — or a rapid de-escalation of the energy shock — stays the most powerful escape hatch from this global tightening cycle. But until geopolitics gives central banks a reason to exhale, market participants and policymakers alike must navigate a world where elevated-for-longer is no longer a risk scenario. It is the baseline — and whether India can make the most of shifting winds in global trade will go a long way towards determining how well it weathers the storm.

Then again, weathering the storm may turn out to be the easy part. If the doomsayers are right, we may all go the way of the horse, made obsolete by technology. It's worth asking what kind of storm AI actually is. Cheers,

In case you missed them, here are some of the other stories and insights we published the current week, apart from our technical picks in the equity, commodity, and forex markets:

Shaily Engineering, CSB Bank, Premier Energies, Solar Industries, PNB Housing Finance, Deepa Jewellers

What SEBI's new Closing Auction Session proposals mean for F&O traders

What the NSE IPO tells us around the Indian marketplace

MFs raise healthcare, capital goods allocation in August; consumer weight hits decade low

The West must hurry to catch up with Ukraine on AI combat

Chinese restaurant chains put AI on the menu

How high might natural gas prices go?

Firms & Sectors

What’s powering India’s two-wheeler exports?

As roads slow, will diversification pay off for infra firms?

Sectoral share shifts in corporate earnings point to a churn ahead

Startup Street: Do academic courses help entrepreneurs?

Geopolitics & Geoeconomics

Does the BRICS declaration promise political and business advantages to India?

BRICS after New Delhi: Can the Bloc reduce dependence without creating new vulnerabilities?

Is the world ready to take note of the WTO warning?

UP elections: the semi-final before 2029