How the Fed’s Rate Cut Could Change Your Investment Strategy Overnight!

While many investors feel that the Indian stock market indices are expected to be bullish due to positive investor sentiment after the US Federal Reserve’s interest rate cut, let’s take a closer look at how experts view this much-anticipated event.

Finally, the US Federal Reserve cut its policy rates by 50 bps in September 2024, its first cut in four years. The Fed Funds rate has come down from 5.25-5.5% to 4.75-5%. The impact of this anticipated rate cut on the US economy and stock markets can be understood as follows:

• When interest rates fall, borrowing and saving rates also decline. This reduces the cost of borrowing, production, and consumption. However, the impact is not immediate due to a lag in transmission.
• Loans taken at higher rates by producers before March 2023 were hedged and locked at lower rates as prevalent then. For borrowers who had taken loans in March 2022, their loans would have been locked at around a 0.5% policy rate. So now, the refinancing of those loans will be at much higher rates. Hence, long-term borrowers will still have to pay at higher rates, negating the interest cut impact.
• For corporations that were cash-rich and did not need to borrow, the rate cut will mean lower earnings from interest on their cash reserves.
• The recent data on unemployment and wages from the US has not been encouraging. This has resulted in a muted reaction to the Fed rate cut announcements so far.

What it Means for Indian Stock Markets

The RBI had also raised its policy rate to record highs, like many other central banks, due to high inflation after the pandemic. While inflation in India has not risen as steeply as in the US, the RBI was able to address the inflation issue to a manageable level much faster than its US counterparts.

With inflation concerns being taken care of, will the RBI be looking at an opportunity to prioritize growth in the coming days? While the increase in US interest rates in the past has been much sharper compared to India, reducing the gap between the two interest rates, a reduction in rates by the RBI may not make much of a difference.

Experts feel that the RBI is expected to maintain an accommodative policy stance. They also believe that RBI’s rate cuts may be smaller than the US Fed’s to maintain wider spreads. Higher spreads might make Indian stocks more attractive for FIIs, further benefiting large-cap stocks that are FII favorites. Sectors like Auto, BFSI, and IT, which are sensitive to interest rates, may also benefit from a rate cut in India.

What Should Investors Do?

Mid and small-cap stocks have seen a sharp rally and have outperformed large-cap stocks recently. Will they continue to be bullish as an increase in the interest rate spread could bring more FII inflows into the Indian stock market? Or will uncertainty around the US presidential result dampen sentiment, tilting preferences toward safer large caps? It will be interesting to watch. Investors should also note that history has shown many times that quality large-cap stocks are safer and are preferred by investors when economic growth is expected to be flat.

Disclaimer: This blog has been written exclusively for educational purposes.

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Source: Moneycontrol

Date: 20th September