Impact of the US Fed rate cut buzz in the market

In a recent speech, the Federal Reserve chairman, Jerome Powell, strongly hinted that the US central bank is prepared to start the rate-cut cycle. The Fed may reduce the rates in September itself. After this speech, the stock market across the globe has gained. Why are markets across the globe cheering the rate cut by the US central bank? In this article, we try to answer all your questions about rate cuts and their impact.

What is the US Fed rate issue?

Post-COVID, most governments infused liquidity in the system to boost the economy. The aftereffect was an increase in inflation. To combat inflation, the central bank in the US (and other countries) started to increase the interest rate. The rate hike began in 2022 and continued until 2023. The central bank's goal was to slow down economic activity and reduce demand for goods and services, which can help lower prices - eventually, inflation.

However, a high interest rate for a long time is not ideal for the economy. High interest rates could lead to a recession. The aggressive rate increases may suppress economic growth and increase unemployment. And that is what happened in the US in recent months.

However, the US central bank has successfully brought inflation back to its target levels. Now, they plan to reduce the interest rate so the economy does not go into recession - there is a soft landing.

Will the US cut the Fed rate?

Let's examine the inflation figures, which are a crucial factor in justifying the rate cut:

As of August 2024, the annual inflation rate in the United States is 2.9%. It is the lowest the country has seen since March 2021.
These numbers are much better compared to 6.5% in 2022 and 3.3% in June 2024.
The graph below shows the fall in inflation numbers since June 22. It finally reached 2.9% in July 2024.

The Fed Chairman recently said, "The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks. It seems unlikely that the labor market will be a source of elevated inflationary pressures any time soon. We do not seek or welcome further cooling in labor market conditions."

It won't be wrong to say that the US Fed will most likely cut the interest rate in its next meeting due in September. Investors need to look at the percentage point by which the rates will be lowered.

Impact of the fed rate on global markets

The US fed rate is closely observed globally as its impact is significant. Here is how the lowering of interest rates will impact the different areas of global markets:

Currency Exchange Rates: The US dollar tends to weaken, making it cheaper for foreigners to buy US goods and services. It can boost exports for US companies but also lead to higher prices for imported goods.
Capital Flows: Investors may seek higher returns in other markets, leading to capital outflows from the US. It can put pressure on emerging market currencies and economies that rely on foreign investment.
Stock Markets: Lower interest rates can stimulate economic growth and corporate earnings, leading to higher stock prices. However, the impact can vary across different sectors and regions.
Bond Markets: Bond prices generally rise when interest rates fall, as existing bonds become more attractive to investors. It can benefit bondholders, but it can also lead to lower returns for new investors.
Commodities: Lower interest rates can increase demand for commodities as investors seek alternative investments. It can drive up commodity prices, such as oil and metals.

How will the US Fed rate cut impact Indian markets?

Let us look at how the US Fed rate cut will impact the Indian market:

Increased Foreign Investment: When the interest rates were high in the US, the US investors preferred to keep money in the US as they were getting higher returns on safe US Treasury securities. With the upcoming rate cut by the Fed, the US Treasury securities yield will reduce. As a result, investors will explore emerging markets like India for investment with higher returns. This can lead to an inflow of foreign capital into Indian equities and debt markets. As more foreign institutional investors (FIIs) and foreign portfolio investors (FPIs) invest in Indian markets, the demand for Indian stocks and bonds can increase, potentially driving up prices.
Some sectors to benefit directly: Stocks from sectors like Information Technology (IT) will directly benefit from rate cuts. If the Federal Reserve begins cutting rates, borrowing costs in the US will decrease. It could encourage large corporations to expand their IT budgets, potentially boosting order volumes for Indian IT firms.
Impact on the Indian Rupee: With an increase in foreign investments, there is often a higher demand for the Indian Rupee as investors convert their foreign currency into INR to invest in Indian markets. It can lead to an appreciation of the rupee against the US dollar.
Bond Market Rally: Lower interest rates globally and in India can lead to a rally in the Indian bond market as the yield on existing bonds becomes more attractive relative to new issues. This can reduce borrowing costs for the government and corporations, potentially leading to more capital investments and economic growth.

Before you go

After a long wait, the US central bank will start the rate-cut cycle. The buzz of a US Fed rate cut has wide-ranging effects on the Indian markets, influencing everything from stock prices and bond yields to currency values and inflation. For investors, understanding these dynamics is crucial for making informed decisions. While the anticipation of a Fed rate cut can create opportunities for higher returns, it also comes with risks, particularly related to currency volatility and potential asset bubbles.