US Fed Cuts Interest Rates by 50 bps: Analysing the Impact on Indian Markets

On Wednesday, September 18, 2024, the US Federal Reserve made a pivotal move by reducing its benchmark lending rates by 50 basis points (bps). This significant rate cut, the first in over four years, is aimed at mitigating a potential slowdown in the labour market. The Federal Open Market Committee (FOMC) adjusted the key overnight borrowing rate from the previous 5.25% - 5.5% to a new range of 4.75% - 5%, reversing the rate-hiking trend that began in 2022.

What's Next? The Fed's Roadmap

The Fed's "dot plot" — a chart depicting individual officials’ rate projections— forecasts an additional 50 bps reduction by December 2024, potentially lowering rates to between 4.25% and 4.5%. 

Eyes are now set on 2025, with projections hinting at rates dipping even further to between 3.25% and 3.5%. This forward-looking approach suggests a significant pivot in policy aimed at fostering long-term economic stability.

Market Response to Past Federal Reserve Actions

Over the past 25 years, market reactions to the Fed's rate cuts and hikes have varied:

• 2001: Marked by the dot-com bubble burst and 9/11, the Fed slashed rates 11 times, yet the Dow Jones fell by 7%.
• 2002-2003: Post the initial cuts, two further reductions between November 2002 and June 2003 spurred a 4% increase in the Dow Jones and a 14% rise in the Nasdaq. 
• 2004-2006: During an intense cycle of 17 rate hikes amidst a housing market boom, the Dow Jones rose by 7.5%, reflecting strong economic conditions despite tighter monetary policy.
• 2007-2008: The global financial crisis prompted the Fed to slash rates 7 times; however, the Dow Jones and Nasdaq fell by 4% and 14% respectively, as the financial crisis deepened.
• 2008: Another drastic cut to zero rates in October saw the Dow Jones drop an additional 4% by December amid widespread economic pessimism.
• 2015-2018: With the Fed raising rates 9 times, the Dow Jones and Nasdaq rose nearly 30% during this period.
• 2019: Three rate cuts from August to October nudged the US markets upwards by up to 2%.
• 2020: The onset of the COVID-19 pandemic triggered a swift reduction in rates back to zero, with the US markets initially plummeting over 20% in just two weeks before a significant recovery ensued.
• 2022-2023: 11 rate hikes by July 2023 led to moderate single-digit returns, followed by a notable surge with US markets climbing over 20% in anticipation of monetary easing.

Broader Impact of Fed Cycles on Indian Markets

A recent study by Capital Mind reveals the resilience of Indian markets to the fluctuating tightening and easing cycles of the Fed. 

• During the Federal Reserve's easing monetary policy phase between July 1990 and February 1994, the Nifty saw an impressive surge of 310%. 
• However, the Nifty saw declines during certain tightening periods, falling by 23% from February 1994 to July 1995 and by 14% from March 1997 to September 1998.
• Conversely, during the tightening phase from June 2004 to September 2007, the Nifty soared significantly by 202%.
• The easing cycle from 2007 to 2015 led to a 70% increase in the Nifty, which was followed by a 43% rise during the tightening cycle from 2016 to 2019.
• Once again, the Nifty saw a rise of 53% during the easing period from 2019 to 2022, and a further 50% increase during the subsequent tightening phase from 2022 to 2024. 

Conclusion: Broader Forces at Play

While interest rate adjustments by the Federal Reserve often trigger immediate market reactions, a deeper analysis of past events reveals a more complex relationship between monetary policy and market trends. Historical data suggests that markets do not always respond predictably to Federal Reserve actions. Significant events, such as the dot-com bubble, the 2008 financial crisis, and the COVID-19 pandemic, show that initial market movements post-Fed decisions are varied and often short-lived. 

Over the long term, it is broader economic indicators and corporate earnings that primarily dictate market directions. This pattern is evident not only in the US markets but also in other indices like India's Nifty, which has shown resilience and growth irrespective of the Fed's tightening or easing cycles. Ultimately, while monetary policy is a crucial economic lever, markets are influenced by a confluence of diverse factors.

What’s Next for Indian Markets?

Historically, lower interest rates in the US have boosted the appeal of emerging markets by lowering the yields on U.S. bonds. Typically, lower interest rates decrease borrowing costs and stimulate business expansion. This positive outlook can boost equity markets as investors seek growth opportunities.

In the past, Indian markets have shown resilience during periods of rate cuts, and a similar upbeat sentiment is anticipated currently. Moreover, there has been a noticeable uptick in net foreign portfolio inflows into Indian equities — a trend that is likely to continue. With its strong GDP growth, stable political environment, and increasing domestic consumption, India continues to be an attractive destination for these capital flows.

Investment Strategies for Indian Investors

Although rate cuts generally boost equities, it's important to remember that interest rates are just one of many elements that influence market dynamics. Moving forward, Indian markets are likely to stay sensitive to global factors in the near term, with potential short-term volatility, especially in rate-sensitive sectors such as banking, real estate, and infrastructure.

For Indian investors, the "buy on dips" strategy has proven effective in the ongoing bull market. However, given the current lack of valuation comfort in the broader market, focusing on quality large caps may offer a safer avenue for long-term investment. 

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