US Fed Cuts 50 bps After 4 years: Market Impact & What It Means for India

Remember when the US Federal Reserve seemed to have an iron grip on global markets? Well, those days might be over. The Fed just made a significant move that could shake things up worldwide.

In a surprise twist, the Fed cut interest rates by 50 basis points. This is the first time they’ve done this in four years! They just hit the pause button on their rate hike spree.

But why did they do it? And what does this mean for you and me? Let’s dive in.

The Federal Reserve’s Decision

The US Fed’s decision to cut interest rates marks a significant shift in monetary policy. It aims to support a weakening job market and achieve a soft landing while inflation remains relatively low.

• Rate Reduction: The Fed slashed the benchmark interest rate by 50 basis points (bps) to 4.75%-5.00%, marking a significant shift in monetary policy.
• Four-Year Break: This was the first rate cut in four years, signaling a potential easing of monetary tightening measures.
• Inflation Targeting: The Fed maintained the key borrowing rate at a 23-year high for 14 consecutive months to combat high inflation. However, with inflation falling to a three-year low, the focus shifted towards supporting a weakening job market.

Reasons for the Rate Cut:

• Easing Inflation: The Fed’s decision was primarily driven by a significant decline in inflation, which fell to a three-year low of 2.5% in August.
• Softening Job Market: The US Fed also seeks to support a weakening job market and achieve a soft landing, avoiding a sharp recession.

Impact on Borrowing Costs:

• Lower Interest Rates: The rate cut will lower the rates at which commercial banks lend to consumers and businesses.
• Affordability: This will make borrowing more affordable, stimulating spending and investment across various sectors.

Future Rate Projections:

The Fed indicated plans for additional rate cuts, projecting a total reduction of 1.5 percentage points by the end of 2026. The benchmark interest rate’s final target range is 2.75% and 3.00%.

Global Market Reactions to the Fed’s Rate Cut

• NSE: The benchmark index Nifty50 opened at 25,487.05 and, within the early hours, touched a high of 25,611 points 
• Gift Nifty: The Gift Nifty index on the National Stock Exchange (NSE) surged by nearly 135 points immediately following the Fed’s rate cut announcement. However, the gains were short-lived, and the index retreated to near pre-rate-cut levels by the end of the trading session.

• S&P 500: The S&P 500 initially rose by 1% but declined by 0.3%.
• Nasdaq 100: The Nasdaq 100 index also experienced a short-lived rally, followed by a 0.5% decline.
• Japan: The Nikkei index in Japan surged over 2.5%.
• Hong Kong and Taiwan: Hong Kong and Taiwan markets remained relatively flat.
• South Korea and China: South Korea and China markets experienced slight declines of 0.6-0.8%. (Source: Moneycontrol)

Broad-Based Sell-Off:

• Across Asset Classes: The rate cut led to a widespread sell-off across various asset classes, including stocks, Treasuries, corporate bonds, and commodities.
• Unprecedented Pullback: Bloomberg reported that a broad-based sell-off following a Fed policy decision had not been seen since June 2021.

Impact on Indian IT Stocks:

• Initial Gains: US-listed ADRs of Infosys and Wipro initially rose, reflecting positive sentiment towards the rate cut.
• Short-Lived Rally: The gains were short-lived, and both stocks returned to pre-rate-cut levels.

Gold Price Surge:

• Record High: Gold prices reached an all-time high following the Fed’s rate cut, driven by a weaker US dollar.
• Spot Gold: Spot gold prices surged to $2,592.39 per ounce, representing a 0.9% increase.
• US Gold Futures: US gold futures also rose, settling 0.2% higher at $2,598.60.

The Ripple Effects of the US Fed Rate Cut on India

Foreign Capital Inflows:

One of the most immediate likely effects of the rate cut is the potential increase in foreign investment in India. Investors favor US Treasury securities for higher returns when US interest rates are high.

However, with a rate cut, yields on these securities will decrease, prompting investors to seek better returns elsewhere, including in Indian equities and debt markets. This shift could lead to a substantial inflow of foreign capital into India, driving demand for Indian stocks and bonds, which may increase prices.

Rupee Appreciation and Its Implications:

The influx of foreign capital will also likely affect the Indian Rupee (INR). As foreign investors convert their currencies into INR for investment purposes, demand for the rupee will rise, potentially leading to its appreciation against the US dollar. A stronger rupee can have mixed effects. At the same time, it may lower the cost of imports (especially crucial commodities like oil). It could also negatively impact Indian exporters by making their goods more expensive for foreign buyers.

Lower Borrowing Costs and Market Trends:

Lower interest rates globally typically lead to a rally in bond markets. This could mean existing bonds become more attractive in India as their yields appear favorable compared to new issues. Consequently, this dynamic may lower the government’s and corporations’ borrowing costs, encouraging more capital investments and stimulating economic growth.

Impact on Sectors:

Certain sectors are poised to benefit directly from the Fed’s rate cut. For instance, the information technology (IT) sector may see increased demand as US corporations expand their IT budgets due to reduced borrowing costs. Other sectors, such as consumer goods and infrastructure, could also experience growth as cheaper financing becomes available.

RBI’s Stance on Interest Rates

The Reserve Bank of India (RBI) will need to consider its policy response to the Fed’s actions carefully. Historically, Indian monetary policy has been influenced by US rates. However, RBI governor Shaktikanta Das has already signaled that India is not compelled to follow suit and reduce its rates. The governor emphasized that maintaining financial stability remains a top priority for the central bank.

Conclusion

Overall, the Fed’s rate cut has the potential to significantly impact India’s economy through increased foreign investment, currency dynamics, lower borrowing costs, and sectoral growth. However, the ultimate effects will depend on various factors, including the RBI’s policy response and the broader global economic environment.

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