Market pundits do not seem to be too enthused about the impending rate cuts by the US Federal Reserve, the first in over four years.
For one, a 25-basis point (bp) rate cut is already baked into the prices and may not move the needle much for the benchmark indices which are trading at or near historically-high valuations. A 50-bp rate cut may jolt the markets into action but the effects are likely to be temporary, as participants digest the reasons for the larger cut and reflect on the health of the global economy. Lastly, rates cuts in India are likely to happen with a lag, most likely in the last quarter of CY24.
“I am not in the camp that is overly excited about interest rate cuts because such cuts in the past have also indicated that the economy is slowing down or entering a recession,” said Rahul Singh, CIO - Equities, Tata Asset Management.
Singh believes that markets perform best when interest rates are stable or gradually sliding down, and the economy is also slowing down gradually. “When GDP growth begins to decline sharply, prompting sharp rate cuts to support the economy, it’s not necessarily a positive signal for equities. The assumption that lower interest rates automatically translate to better outcomes for equities, therefore, has to be more carefully analysed,” he said.
Rate-cut cycles
Indian indices saw a sharp sell-off during the rate cutting cycle over January 2001 to December 2001. The market saw a steady performance initially, and a sharp sell-off later, during the 2008 Fed rate-cut cycle from September 2007 to December 2008.
“The market often anticipates rate cuts, leading to inflated equity valuations before the cuts even happen, something which has been happening recently. The rate cuts could even have a negative effect on equities, especially if US GDP growth slows down from 3 per cent to, say, 1 per cent over a few quarters,” said Singh.
According to Deepak Jasani, Head - Retail Research at HDFC Securities, the Fed commentary and its outlook on the global economy and roadmap for rate cuts will be crucial. He feels that global markets are already showing some signs of fatigue and a 25-bp rate cut, already discounted in current valuations, may lead to a minor correction probably with a lag.
“The downside will be limited because of domestic liquidity and buying on dips. A 50-bp rate cut will see a sharp rise in benchmark indices initially but the upmove may not sustain, as the focus shifts to the reasons that led the Fed to go for a bigger rate cut,” he said.
Impact in India
Rate-sensitive sectors such as real estate and automobiles may benefit. "Realty stocks have already rallied significantly over the past few months. Automobile inventories have been piling up and it remains to be seen whether a rate cut back home, with some lag, will boost sales in any meaningful way,” said Jasani.
UR Bhat, Director at Alphaniti Fintech, believes that FPI flows will be positively impacted in general and investors may look more kindly towards riskier assets over time. Companies that borrow internationally may benefit from the lower interest rates, he said.
“We do not see much merit in using previous rate-cutting cycles to predict market behaviour during the upcoming US rate-cutting cycle, which is a natural response to inflation coming under ‘control’. The bulk of the 2001, 2009 and 2020 cycles were in response to a crisis,” said a note by Kotak Institutional Equities (KIE).
The current macroeconomic parameters are far better than those in previous periods; both corporate and household balance sheets are in decent shape, the note said. KIE expects a moderate slowdown during the upcoming cycle, with the trajectory of cuts largely driven by the velocity of slowdown.