The trajectory of U.S. monetary policy once again occupies the centre of global financial discourse. These are tumultuous times, times of confusion and speculation on the rapidly unfolding course of events. As W. B. Yeats wrote eloquently in his classic poem “The Second Coming” (1919), “The best lack all conviction, while the worst are full of passionate intensity”.
Perhaps what Yeats’s wrote over a century ago resonates even truer today. As markets debate the sequencing of rate cuts, the U.S. Federal Reserve’s signaling, particularly its February 2026 communication that further rate hikes remain possible, reveals a central bank still prioritizing inflation containment above all else.
The prevailing uncertainty has divided analysts: some anticipate imminent easing, others expect a prolonged pause, and a minority still see upside risks to rates. My assessment aligns with the view that no immediate rate change is likely, at least through the first half of the year.
This is not merely a domestic American policy debate. The Federal Reserve sits at the apex of the global monetary hierarchy. Its decisions ripple through capital flows, currency markets, debt sustainability frameworks, and growth trajectories across emerging markets. For countries like India, the implications are nuanced: risks exist, but so do buffers. Thus, while the Indian economy cannot be an “island in the stream” (Ernest Hemingway), there are elements of both coupling and decoupling with the broader American monetary and fiscal policies. A critical evaluation must, therefore, examine not only the mechanics of rate policy but also the structural and cyclical consequences of a “higher for longer” stance.
I. The Sequencing of Rate Cuts: Why Timing Matters?
The sequencing of rate cuts is not simply about whether rates go down; it is about when, how quickly, and under what macroeconomic justification they move. The Fed’s insistence that further rate hikes remain possible signals three key realities:
- Inflation remains insufficiently anchored at 2%. b. The labor market retains resilience.
- The Fed is unwilling to risk a premature pivot reminiscent of the stop-go cycles of the 1970s.
By keeping tightening “on the table,” the Fed preserves strategic options and choices. However, such optionality is not costless. Financial markets tend to respond more strongly to forward guidance than to actual rate moves. Even the suggestion that hikes remain possible can generate short-term volatility. Higher policy rates increase borrowing costs for firms and households. Growth stocks, valued primarily on discounted future earnings, face disproportionate pressure because higher discount rates reduce present value.
Meanwhile, bond yields may climb, depressing existing bond prices and creating mark-to-market losses across portfolios. But the more significant question is whether the Fed’s communication is reactive or pre-emptive. If the central bank is signaling vigilance rather than imminent action, markets may adjust gradually. If, however, inflation data were to re-accelerate, forcing renewed tightening, the repricing could be disorderly. The central issue is credibility.
The Fed must balance inflation-fighting resolve with financial stability concerns. The sequencing of cuts—if delayed too long—risks unnecessary growth sacrifice. If advanced prematurely, it risks inflationary spiral.
II. The “Higher for Longer” Doctrine: Discipline or Rigidity?
The “higher for longer” narrative has become a defining feature of post-pandemic monetary strategy. It rests on the belief that sustained restrictive policy ensures inflation expectations remain anchored. Yet, this stance raises critical questions: Is inflation still demand-driven, or has it become structurally supply-side? Are real interest rates already sufficiently restrictive? Does prolonged tightness create asymmetric risks for the global system? Currency markets often respond most directly. When U.S. rates remain elevated relative to other major economies, capital gravitates toward dollar-denominated assets. This strengthens the U.S. dollar.
Historically, a strong dollar tightens global financial conditions by increasing the local currency burden of dollar-denominated debt, reducing commodity purchasing power for import-dependent nations, and triggering capital outflows from emerging markets. However, markets typically price in anticipated policy trajectories. If the Fed merely reinforces expectations rather than surprises investors, adjustments can be orderly. Volatility intensifies when forward guidance and actual data diverge.
Critically, the “higher for longer” approach reflects the Fed’s institutional memory of the 1970s inflation cycle. But today’s global economy is structurally different—characterized by higher debt levels, deeper financial integration, and digitalized capital mobility. Prolonged tightness in such an environment carries systemic implications that extend far beyond U.S. borders.
III. Transmission Channels to Emerging Markets- The Grammar of Development
Emerging markets (EMs) are disproportionately sensitive to Fed policy due to structural asymmetries in the international monetary system. The transmission occurs via several channels:
- Capital Flows. Higher U.S. yields make American assets more attractive. Portfolio investors reallocate funds toward U.S. Treasuries and corporate bonds, reducing inflows into EM equities and debt. This can lead to asset price corrections and liquidity constraints in emerging economies.
- Exchange Rates. A stronger dollar exerts depreciation pressure on EM currencies. Depreciation, in turn, fuels imported inflation—especially for energy and food—forcing local central banks to maintain tighter policy than domestic conditions might otherwise warrant.
- Debt Sustainability. Many emerging markets borrow in dollars. When the dollar strengthens and U.S. rates remain elevated, debt servicing costs rise. Sovereign balance sheets come under strain, and refinancing risk increases.
- Policy Convergence Pressure. To prevent destabilizing capital outflows, EM central banks may be compelled to mirror Fed tightening even if domestic growth conditions are weak.
This imported monetary discipline constrains policy autonomy. Yet, emerging markets today are not the same as during the 1997 Asian Financial Crisis or the 2013 Taper Tantrum. Many hold stronger forex reserves, maintain more flexible exchange rate regimes, and exhibit improved macroprudential frameworks. But it is not always realised- much less felt- that the degree of vulnerability varies significantly across countries.
IV. India: Between Vulnerability and Resilience
India occupies a unique position within the emerging market universe. It combines structural growth strength with persistent external sensitivities.
- Capital Flow Dynamics. India attracts substantial foreign portfolio investment (FPI) in both equity and debt markets. Elevated U.S. yields can slow these inflows or trigger temporary outflows. However, India’s expanding domestic investor base, particularly through systematic investment plans (SIPs), has reduced its reliance on foreign capital compared to a decade ago.
- Currency Stability. The Indian rupee is not fully convertible on the capital account, providing some insulation. The Reserve Bank of India (RBI) actively intervenes to smooth volatility. Moreover, India’s foreign exchange reserves remain substantial, offering a buffer against speculative pressures. However, a persistently strong dollar can widen India’s triple deficits (trade deficit, current account deficit and fiscal deficit), especially given its dependence on crude oil imports. Energy price pass-through into inflation remains a key vulnerability.
- Inflation and Policy Autonomy. If the Fed maintains a restrictive stance, the RBI may face pressure to avoid premature easing. Even if domestic inflation moderates, easing ahead of the Fed risks currency depreciation and capital outflows. This constraint creates a delicate balancing act: Support growth in a developing economy. Maintain external stability. Anchor inflation expectations.
- Growth Implications. India’s structural growth story driven by demographics, digitalization, manufacturing incentives, and infrastructure expansion, remains intact. However, higher global borrowing costs raise the hurdle rate for investment projects. Corporate capex decisions become more cautious when global liquidity tightens. Yet, India’s lower exposure to dollar-denominated sovereign debt compared to some peers reduces immediate systemic risk.
V. The Risk of Dissonance: Inflation vs. Growth
The path ahead is marked by discord between data and expectations. As I have repeatedly argued, the Fed has clearly articulated that easing will resume only upon convincing evidence of inflation approaching 2% or meaningful labor market weakening. As of now, there appears insufficient evidence of either in the early part of the year. Hence, the probability of rates remaining on hold at least until mid-year appears high.
A first cut in July is plausible, but this is contingent on sustained disinflation. The possibility of only 50 basis points of easing in 2026, rather than a more aggressive cycle, remains credible. Indeed, the greater risk may be “less easing” rather than more. For emerging markets, this gradualism is a double-edged sword: Predictability reduces shock risk. Prolonged tightness sustains capital pressure.
VI. Structural Critique of the Fed’s Approach
A critical examination must question whether the Fed adequately internalizes global spillovers. While its mandate is domestic—maximum employment and price stability—the dollar’s reserve status grants its decisions quasi-global authority. Three critiques emerge:
- Asymmetric Burden Emerging markets bear disproportionate adjustment costs. Capital reversals, currency depreciation, and debt stress often occur even when domestic fundamentals remain sound.
- Financial Cycle Synchronization Global financial cycles increasingly synchronize with U.S. monetary policy. This reduces policy independence in smaller economies.
- Over-Reliance on Backward-Looking Data.
A purely data-driven approach risks lagging structural turning points. Inflation often responds with delay to policy shifts. Excessive caution may therefore amplify cyclical downturns. However, counterarguments exist. The Fed cannot be expected to optimize global outcomes at the expense of domestic stability – something which is fraught with grave risks. Moreover, predictable communication reduces volatility relative to surprise-driven policymaking -the case for a “googly” remains weak and unclear.
VII. Gazing into the Crystal Ball- India’s Strategic Response
India’s resilience will depend less on the Fed’s actions and more on domestic structural strength. Key strategies include maintained adequate forex reserves, deepening domestic capital markets, reducing reliance on imported energy, encouraging local currency debt issuance, and sustaining fiscal discipline. India’s push for manufacturing diversification and digital public infrastructure may offset external shocks. Furthermore, the gradual inclusion of Indian bonds in global indices enhances structural inflows.
VIII. Conclusion: A World of Churn and Conditionality
We inhabit a dynamic world, a world of churn and whirl, where central bankers navigate uncertainty with imperfect information. The Fed’s insistence on evidence-based, data-driven policy reflects institutional prudence. Yet, prudence at the centre can generate fragility at the periphery. If inflation convincingly moderates and labour markets soften, easing may begin by mid-year, possibly totalling 50 basis points in 2026. However, the risk of less easing remains tangible.
For emerging markets broadly, and India specifically, the story is not one of inevitable crisis but of managed adjustment. The key variables remain inflation trajectory, labour market resilience, dollar strength, and global growth synchronization. In this complex and multilayered world, pressure is likely, and even inevitable. Sustained stress, however, will depend on whether further tightening appears both credible and necessary.
The Fed may not intend to shape the fate of emerging economies, but by virtue of the dollar’s dominance, it inevitably does. The critical challenge for planners, policymakers, and even those at the helm of affairs in emerging markets, including India, is not to predict the Fed, but to build resilience against its oscillations.
In sum, global financial stability hinges not only on the Fed’s discipline but also on the structural maturity of the emerging world. We watch warily.
ABOUT THE AUTHOR
Dr. Manoranjan Sharma, Chief Economist, Infomerics Ratings is a globally acclaimed scholar. With a brilliant academic record, he has over 350 publications and six books. His views have been published in Associated Press, New York; Dow Jones, New York; International Herald Tribune, New York; Wall Street Journal, New York.
