It has been expected for some time now that the Federal Reserve will begin slashing interest rates. The central bank delivered with a bang, cutting the federal funds rate by 50 basis points on Wednesday, its first reduction since March 2020—a step that will have an impact on moves by other central banks, global fund flows, and sentiments in equity markets.
Ahead of the meeting, the opinion on the extent of interest rate cut had been firmly divided. Conservative analysts had expected the Fed to cut interest rates by 25 bps. However, lower than expected job additions in August had others calling for a more aggressive 50 bps cut. The Fed has delivered to their expectations. In a way, by the outsized reduction in rates, the Fed has signalled confidence in its earlier inflation-controlling measures and the need to focus on the jobs and economy.
"This looks like an apt decision from risk-management perspective, the economic cost of this preemptive 50 bps cut is lower than the cost of waiting and then being forced into a bigger cut later if incoming data suggest further deterioration in the labour market," noted Siddharth Chaudhary, senior fund manager, fixed income at Bajaj Finserv Asset Management.
Data released last week showed that the US consumer prices rose 2.5 per cent in August, from 2.9 per cent in July—its fifth straight annual drop and its lowest in three years. At the same time, jobs data has been mixed. The US economy added 1,42,000 jobs in August, lower than analysts expectations, but unemployment rate also ticked lower to 4.2 per cent from 4.3 per cent. In July, the economy had created just 89,000 jobs, the data had showed.
"Actions speak louder than words, and despite messaging that today was a one-off move, the Fed has signaled a high sensitivity to labor-market weakness," said economists at Nomura.
"Although (chair Jerome) Powell mentioned low 4's as a healthy unemployment rate, the jump of 0.22 percentage points in the unemployment rate in the July employment report was clearly one of the factors behind the 50 bps cut," they said.
Looking ahead, the Fed is expected to slow the pace of rate cuts to 25 bps in future meetings. Still, market watchers see the Fed slashing its benchmark interest rate by another 50 bps through the remainder of 2024 and by a full 1 per cent through 2025. So, by the end of 2025, the Fed rate could fall to a range of 3.25-3.50 per cent from the 4.75-5.0 per cent now.
The Fed's decision to cut interest rates will have a bearing on global markets. Fund flows to emerging markets like India could go up as investors look for higher rates and returns.
"From inflation is transitory to higher rates for longer, Fed has come a long way to meet market expectations. This rate cut will facilitate flows to the emerging market assets with weaker dollar and lower rates," Nilesh Shah, MD, Kotak Mahindra AMC, pointed out.
The Fed's move could open the doors for other central banks to slash their interest rates. The European Central Bank (ECB) has already cut its key interest rate by 25 basis points last week. Ahead of the Fed decision on Wednesday, Indonesia's central bank surprisingly slashed interest rate by 25 bps, its first cut in more than three years.
Will the Reserve Bank of India too be tempted to cut rates now?
With CPI (consumer price index) inflation coming in below Reserve Bank's 4 per cent target for two consecutive months, India's central bank is expected to start cutting rates soon. But, with strong economic growth, and volatile food prices, Governor Shaktikanta Das is certainly not going to be in a mood to rush.
"Inflation has moderated from its peak of 7.8 per cent in April 2022 into the tolerance band of +/-2 per cent around the target of 4 per cent, but we still have a distance to cover and can not afford to look the other way," he said addressing a gathering at the Future of Finance Forum 2024 organised by the Bretton Woods Committee in Singapore last week.
Sonal Varma, chief economist India and Asia ex-Japan at Nomura is among the one who believes the RBI is likely to spring a surprise with a 25 bps repo rate cut in the next monetary policy committee meeting in October as "downside risks are rising" for both GDP growth and CPI inflation. Many others, though still believe that any rate cut was unlikely before December.
Madhavi Arora, lead economist at Emkay Global Financial Services, feels the RBI still has the flexibility to remain focused on domestic inflation and risk management and a case for an early cut is less likely.
"The RBI is likely to maintain its wait-and-watch stance and focus on being actively disinflationary, with a first rate cut likely by December," said Arora.
On Thursday, the BSE Sensex was trading up more than 300 points or 0.4 per cent in afternoon trading. Earlier in the session, it touched a fresh life high of 83,773.61. The NSE Nifty 50 was up around 45 points (0.2 per cent). However, broader markets saw a sharp correction; the BSE midcap and smallcap indices, for instance, were down more than 1 per cent.
"We believe equities will do well on back of US monetary policy normalisation, albeit with volatility, given there is concern about risk of a hard landing (US recession). On Indian equity markets, given valuation is above long period averages, we may see consolidation in broader markets and investor preference towards large cap and value stocks," said Yogesh Kalwani, head of investments at InCred Wealth.
Unmesh Kulkarni, managing director, senior advisor at Julius Baer India, observed that historically US equity markets had performed well during Fed rate-cutting cycles, particularly if a recession was avoided.
"The global macroeconomic environment is currently favourable for equities. However, volatility in equity markets is likely to stay elevated, given the uncertainty around the upcoming US elections, ongoing concerns of economic slowdown/ recession in the US, as well as other (e.g., seasonal, geopolitical) factors," he said.
From an Indian equity perspective, the near-term sentiment would depend on the prevailing mood in the global markets, he pointed out.
"The Indian economy in itself is on a solid footing and compares favourably over other emerging markets. Valuations, however, are rich, and this may limit near-term upside, unless there is a runaway global rally," said Kulkarni.