Fed holds rates as US stagflation fears rise; will Indian stock markets feel the heat?

The US Federal Reserve has kept its benchmark policy rate unchanged at 4.25–4.50 per cent, flagging continued uncertainty from President Donald Trump’s tariff-led trade policies. The Fed maintained its “wait-and-watch” stance, warning that inflation could rise and growth may soften as the impact of tariffs filters into the economy.

The central bank now forecasts GDP growth at 1.4 per cent for 2025, down from its earlier projection of 1.7 per cent. Unemployment is expected to climb to 4.5 per cent, and inflation is forecast to touch 3 per cent — well above current levels — raising fresh concerns of a potential stagflation scenario in the US.

Fed Chair Jerome Powell noted that inflation could accelerate in the coming months as tariff effects become more visible in consumer prices. However, the May inflation data offered some relief: the Consumer Price Index (CPI) rose 0.1 per cent month-on-month and 2.8 per cent year-on-year, against expectations of a sharper rise.

Economists believe that while the current US macro environment is complex — marked by slowing growth and sticky inflation — strong employment data, measured wage growth, and steady monetary policy reduce the immediate risk of stagflation.

Impact on India

India is relatively insulated from a US economic slowdown, given its domestic demand-led growth model. Exports account for only around 12 per cent of India’s GDP, compared with 19 per cent for China and 82 per cent for Vietnam, according to a Goldman Sachs report.

However, despite India’s economic insulation, its stock markets remain closely correlated with the US. Goldman Sachs notes that movements in India’s Nifty 50 index have shown a strong relationship with the S&P 500 Composite Index over the past decade, reflecting the interconnected nature of global capital markets.

A prolonged Fed pause could delay interest rate cuts by other central banks, including the Reserve Bank of India (RBI), potentially tightening global liquidity. Analysts also point to increased FPI interest in India, driven by a weakening US dollar and India’s strong economic fundamentals.