About two-thirds of Wall Street traders are expecting a 50 basis point cut on Wednesday and a total of 100 basis point cuts by the end of December 2024. However, the market has been wrong in the past when it comes to predicting the mood of the interest rate-setting body, the Federal Open Market Committee (FOMC).
If Powell cuts rates by 25 basis points but says he won’t let ugly inflation rise again, that could be positive for the market. However, if the Fed cuts rates sharply by 50 basis points and says it needs to do more and is concerned about growth, that could put downward pressure on stock prices as investors could see that as a signal that the US economy is slipping into recession.
On the one hand, the Fed has to lower interest rates to support the economy, but on the other hand, it wants to prevent inflation from flaring up again.
Read also | The US Federal Reserve meeting begins. Does the stock market need an interest rate cut of 25 or 50 basis points?
“They will sell two different things to two different audiences. To the fixed income people, they will tell them that inflation is coming down and that is why they are cutting rates. And to the equity market, they will not like to tell them that they are cutting rates because the economy is slowing down,” Nilesh Shah, managing director of Kotak Mahindra Mutual Fund, told ETMarkets.
When asked to comment on the extent of the Fed’s interest rate cuts, he said the actual rate would be well below market forecasts.
An ideal and possible outcome, analysts say, would be a 25 basis point rate cut with a dovish message suggesting a series of rate cuts.
At the start of the rate cut cycle, S. Naren of ICICI Prudential Mutual Fund, top equity picker on Dalal Street, said the ideal strategy is to focus on asset allocation.
“A rate cut typically signals a weakening economy, which means equity returns may not increase significantly. That’s why it’s so important to de-leverage and limit excessive risk in your portfolio. Instead, focus on investing in quality stocks – quality-oriented value stocks rather than aggressive value stocks,” he said.
In addition, he believes one should avoid leverage – or, if one has already bought leveraged shares, reduce them to zero and book profits.
Over the last three decades, the Fed has announced a 50 basis point rate cut 10 times, resulting in an average return of 1.6% for Nifty, a study by Capitalmind shows.
“A 25 basis point cut was followed by a more modest median Nifty return of -0.5 percent. There are outliers too, for example the nearly 7 percent decline in October 2008 following a 50 basis point cut at the height of the global collapse during the global financial crisis,” Capitalmind said.
Lower interest rates can also lead to higher inflows from foreign investors. Ahead of the rate cut cycle, foreign investors have already invested Rs 31,000 crore in Dalal Street this month.
Investors believe that interest rate cuts would have a positive impact on banks and NBFCs.
“Rate cuts could lead to big gains in the investment portfolio of banks. They are currently the cheapest sector in the entire market (historically). So I think rate cuts would be a positive benefit to banks and NBFCs. It can also help them with their borrowing costs. That is how we see it at the moment,” Naren said.
Meanwhile, Wall Street also expects the RBI to cut interest rates by at least 25 basis points by December.
“Why should the RBI rush? India is the fastest growing major economy. Inflation is coming down and will be below 4%, but headline inflation will be between 4% and 6%, which is the upper end of the RBI’s target range. The rupee is stable. There are foreign inflows in the debt market. There is no need for the RBI to follow the Fed immediately. It has all the time in the world to hit the ball whenever the Fed decides to do so,” said Nilesh Shah of Kotak.
Also read | How S Naren is investing as the stock market shifts from value to quality
