Understand the Impact of Fed's 50 bps Rate Cut on Indian Stock Market

The US central bank decided to start the easing cycle (rate cut), and the first announcement was surprising for most. Everyone is talking about the rate cut and its impact on the global market. In India also, it is a hot topic. This is the article to read to understand rate cuts and their impact. So, let us get started.

What is the Fed Rate?

The Fed Rate is a key interest rate set by the Federal Reserve in the United States. It represents the interest rate at which banks lend reserve balances to each other overnight. It is similar to the Repo rate that the Reserve Bank of India (RBI) set in India for the banks.

Let us understand what exactly it means for the banks. Imagine the Federal Reserve sets the Fed Rate at 2%. It means that banks can borrow money from each other overnight at a rate of 2%. When the Fed raises the Fed Rate, it generally leads to higher interest rates for loans like mortgages and car loans. Conversely, a lower Fed Rate can lead to lower interest rates.

Fed's 50 bps Rate Cut

The Fed was expected to cut the interest rate in its September meeting as the Fed Chair said in public forums last month that the right time has come for the rate cut. A rate cut of 25 bps or 50 bps was on the cards. Majority believed that the Fed would go with a 25 bps rate cut.

To the surprise of most, the Fed decided to go for a 50 bps rate cut. It was the first interest rate cut since the early days of the Covid pandemic.

Why did the Fed reduce the rate?

Here are some reasons why the Fed decided to go for a rate cut after 4-years:

Weakening Economic Indicators: The Fed observed signs of a slowing economy, such as rising unemployment rates and declining business activity. For example, the July job report showed that the US added 818,000 fewer jobs in the 12 months ended March 2024 than originally reported.
Inflation Concerns: While inflation had been on a downward trend, the Fed remained cautious about the potential for future inflationary pressures. The Federal Open Market Committee (FOMC) members have predicted that Personal Consumption Expenditures (PCE), a measure of inflation tracked by the Fed, will hit 2.3% in 2024, and then fall to 2.1% in 2025.
Global Economic Uncertainty: Geopolitical tensions and trade disputes were also contributing to economic uncertainty.

By reducing interest rates, the Fed aims to stimulate economic growth, encourage borrowing and spending, and prevent a deeper economic downturn. You should know that this decision also carries risks, such as the potential for increased inflation if the economy recovers too quickly.

Impact on Indian economy

Here are some of the impacts of the Fed's rate cut on the Indian economy:

Lower Cost of Borrowing: The Reserve Bank of India (RBI) may respond to the Fed's rate cut by easing its monetary policy, leading to lower domestic interest rates. RBI reducing repo rates can encourage borrowing and investment, stimulating economic activity.
Rupee Appreciation: A Fed rate cut often results in a weakening of the US dollar as investors move their money to higher-yielding economies like India. This may cause the Indian Rupee (INR) to appreciate against the US dollar. While a stronger rupee makes imports cheaper (beneficial for oil imports), it can hurt Indian exports, which become more expensive for foreign buyers.
Inflation: A stronger rupee resulting from higher capital inflows makes imports cheaper, reducing the cost of goods like crude oil, electronics, and other essential commodities. This can help reduce imported inflation in India.
India's Monetary Policy: A Fed rate cut allows the Reserve Bank of India (RBI) more flexibility in lowering its interest rates. With the US offering lower interest rates, capital flight from India to the US becomes less likely. The RBI can reduce its repo rate without worrying about large capital outflows, helping stimulate domestic borrowing, investment, and consumption.

Impact on the Indian Share Market

Below is our impact of the Fed's rate cut on the Indian share market:

Increased Capital Inflow: A Fed rate cut lowers interest rates in the US as we have discussed above. It makes returns on US assets less attractive to global investors. As a result, foreign investors (especially institutional investors) look for higher returns in emerging markets like India. Increased foreign capital inflows into Indian equities can push stock prices higher as demand for Indian stocks rises. On 20 September 2024, the FII net purchase in the Indian equity market was Rs 14,064.05 crore.

Further, with rates expected to drop by over 200 bps in the next two years, India is expected to see a continuous inflow of foreign capital as FII will drawn to the country's robust economic growth.

Market Rally: The higher inflows from FII will fuel a rally in the stock market. We have already seen the market rising post the rate reduction announcement and FII inflows.

Sectoral Impact: Reduction in the Fed rate will benefit certain sectors, such as IT and consumer durables. These sectors may benefit more from FII inflows due to their export-oriented nature. Also, experts believe investors should stick to large caps and focus on sectors such as FMCG, pharma, and private banks.

Impact of Fed rate cut on Indian Rupee

Below is the impact of the Fed Rate Cut on the Indian Rupee:

Strengthening of the Rupee: With Fed interest rates cut, the US dollar (USD) is expected to weaken as lower interest rates make dollar-denominated assets less attractive to global investors. As a result, investors will shift their capital to other currencies, including the Indian Rupee. It will lead to a potential appreciation of the INR against the USD.
RBI Intervention: The Reserve Bank of India (RBI) may intervene in the foreign exchange market to manage the Rupee's exchange rate. If the Rupee appreciates too rapidly, the RBI may sell dollars to prevent excessive appreciation.

What does the future hold?

As mentioned above, the Fed is expected to cut the interest rate further in the coming years. The 9 FOMC members, both voters and nonvoters, see the benchmark fed funds rate at 4.4% by the end of this year, equivalent to a target range of 4.25% to 4.50%. As per analysts, the Fed should announce 50 basis points of cuts in the first quarter of 2025, followed by 25 in the following two, taking a total of 100 basis points of reductions next year to a 3.25%-3.50% range.

On the future rate cuts, Fed Chair Jerome Powell said, “I do not think that anyone should look at this and say, ‘Oh, this is the new pace. I think we are going to go carefully meeting by meeting and make our decisions as we go."

Before you go

Overall, the Fed rate cut is a positive sign for the emerging market like India. But we will have to see how the Reserve Bank of India does with the repo rate cut in India. The Fed rate cut can provide a short-term boost to the economy. It is essential to monitor the evolving economic landscape and potential risks. The Indian government and Reserve Bank of India will need to carefully assess the situation and implement appropriate measures to mitigate any adverse effects.