What is the significance of the Fed’s interest rate cut?
The Fed’s higher-than-expected rate cut of 50 basis points on Wednesday was the first since March 2020, marking the end of the central bank’s monetary tightening cycle. It is also considered the start of the rate-easing cycle worldwide. The consensus on Wall Street is that the Fed may further reduce rates by another 50 basis points in two instalments of 25 basis points each in 2024. Though the American central bank’s interest rate moves are entirely aimed at boosting its economy, they tend to have implications for economies, markets and assets worldwide.
What will be the impact of Fed rate cuts on various markets?
Interest rate cuts in the US tend to be most positive for riskier asset classes such as Asian and emerging markets equities including India. This is because when the Fed eases policy, the dollar tends to weaken against Asian currencies and the US bond yields fall. This is conducive for risky assets as a weaker dollar encourages foreign investors to pump money into markets with better returns and strengthening currencies. For instance, if the rupee firms up, it boosts the value of foreigners’ Indian assets. In the past two years, a lot of foreigners have pulled money out of emerging markets on account of the stronger dollar with the interest rates in the US at the highest since 2001.
Does this mean that the US rate cuts will benefit Indian equities in the coming months?
In theory, lower interest rates should augur well for an emerging market like India with strong growth prospects and a stable policy environment. But it’s not that simple. Despite being one of the fastest-growing economies, many foreign fund managers are not comfortable pumping fresh money into Indian equities now because the market has already run-up in the past three years, making it one of the most expensively valued in the world. This partly explains the relatively tepid reaction of Indian equities to the Fed rate cut. That said, there could be hot overseas money flowing in sporadically, as part of global investors’ overall allocation to Asia or emerging market equity baskets of which India has a significant presence. If the RBI follows suit by cutting rates this year, shares of banks and NBFCs, which have been underperforming the broader markets, could rebound, driving the Sensex and Nifty to new records. Most investors are of the view that banks are the only sector in Indian equities that are cheaply valued.
Will the US Presidential election outcome influence Wall Street’s outlook for US interest rates?
Though the market has taken note of Fed chairperson Jerome Powell’s newly-adopted dovish stance in monetary policy, some believe the course of interest rates in 2025 will depend on who becomes the President. CLSA said investors would be advised to cut their short positions (bets on declines) on the US dollar at the end of the first quarter of 2025 if Donald Trump is elected and in the second quarter of 2025 if Kamala Harris is elected. While the brokerage expects the Fed policy rate at 4.5% by the end of 2024 (currently in the 4.75%-5% range), it sees the policy rate at 3.5% by 2025-end if Harris is elected, and 4%, if Trump is re-elected.
What are the other asset classes to look at when the US Fed cuts rates?
Many investors have been bullish on precious metals like gold and silver in recent months on expectations of interest rate cuts in the US. In theory, gold’s appeal among investors tends to rise in periods of falling interest rates. This is because lower interest rates boost the value of holding bullion, which yields no interest. However, the relationship between precious metals and interest rates is much more complex as gold is driven by factors other than monetary policy.
Source link
