US Fed Expects Three Rate Cuts In 2024; How Does Lower Interest Rates Impact Indian Market?

The US Federal Reserve maintained key fund rates at their highest level since 2001, for the fifth consecutive monetary policy meeting. Also, Fed officials continue to expect three rate cuts scenario by this year-end. Amidst finding inflation still sticky, the trajectory of rate cuts in 2024 has worked as comfort among investors. Lower rates are stimulative for both economy and market-related instruments like stocks.

To support its goals of achieving maximum employment and inflation at the rate of 2% for the longer run, the US Fed on March 20th, decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent.

In its FOMC meeting, Fed officials noted that the risks to achieving its employment and inflation goals are moving into better balance. However, they added that the "economic outlook is uncertain, and the Committee remains highly attentive to inflation risks."

Fed pointed out that the latest indicators in the US suggest that economic activity has been expanding at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. However, it said, "Inflation has eased over the past year but remains elevated, as per FOMC."

On adjusting the target range of key federal funds rate, FOMC said, "The Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 per cent."

Further, the Fed will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities.

Apart from this, FOMC led by chair Jerome Powell continues to expect three rate cuts of 25 basis points each in 2024, however, the trajectory for lowering rates is fewer for 2025.

Fed's March 2024 policy outcomes are on expected lines. Subho Moulik, CEO & Founder, of Appreciate, a SEBI and IFSCA registered fintech company said, "As expected, the Federal Reserve did not change interest rates at today's meeting. During the press conference following his address, Federal Reserve Chairman Jerome Powell repeatedly kept citing the narrative which sums up the trajectory of inflation as he sees it, namely, that the economy is on track for a gradual slowdown in inflation, albeit, there could be a few bumps in the road."

How Does It Impact the Global Market and economy?

Moulik added, "The narrative goes on to bolster what many market participants have been baking in, essentially, that barring unforeseen negative surprises on the strong side, the Fed is settling in for a rate cut in June. All three major US indices rose after Chair Powell's cautiously optimistic remarks, and the S&P 500 sailed past the 5,200 mark."

Further, Moulik said, lower interest rates will be stimulative for the economy, and good for assets like stocks. Now, all eyes will be trained on the personal consumption expenditure figures for February that will be released on March 29. These figures would serve as a touchstone to the question of whether the Fed will truly be in a position to push through with the first of the three rate cuts it has pencilled in for 2024.

What about the Indian Market?

To understand the Fed rates' impact on the Indian market, we first need to understand the differences between RBI and the Fed's pace of rate outcomes since the Russia-Ukraine war that escalated in 2022. The Kremlin's invasion of Ukraine was the focal point of aggressive rate hikes across global central banks as inflation and prices shot up.

According to the Bank of Baroda Economics report, the Russia-Ukraine war acted as a catalyst, leading to a sharp pickup in commodity prices, especially oil. This was also fed into prices of other goods and services, which led to a significant passthrough into core inflation. Amongst major central banks, the Fed (Mar'22) and the European Central Bank (Jul'22) were amongst the last to raise rates. In India, the policy tightening commenced in May'22, with the repo rate being increased to 4.4%. During this phase, India's policy rate differential with US, UK and Europe increased as RBI front-loaded its first rate hike and raised the repo rate by 40bps.

It took nearly a year for the rate-hike cycle to peak, and the differences between RBI and other central banks rates are noteworthy.

Data from the BOB Economics report highlighted that central banks globally moved quickly to increase rates to a sufficiently restrictive level and keep them there until policymakers were sure that inflation would return to target. This marked the peak in the interest rate cycle. For most of the central banks, this point was reached during H2CY2023. For the US, the policy rate peaked in Jul'23 at 5.5%, starting from Mar'22. In comparison, in India policy rate was at its peak within 9 months from the start of the rate cut cycle.

Taking into consideration the magnitude of rate hikes, India has been at the lower end, increasing the policy rate by only 250bps (from the Covid-19 low). As per the BOB Economics report, the increase in case of India has brought the policy rate to the average in the last ten years or so. On the other hand, the policy rate in the US has been increased by 525bps, in the UK by 515bps and in Europe by 450bps. Amongst emerging markets, the policy rate in Mexico was increased by 725bps, in Brazil by 1,175bps and in Russia by 1,575bps.

"As a result, interest rate differential between India and other major economies has narrowed considerably," the BOB Economics report said.

Apart from this, the gap between the CPI inflation target and the policy rates of these central banks also merits discussion. BOB Economics report said, that for India it is 1.4%. For the USA it is 2.3%, the UK 1.25%, China 2.75%, and Euro 1.9%. Here, India's real repo rate looks well below some of the developed nations. For the emerging economies, it was 2.85% for South Africa and over 9% for Brazil.

That being said, the policy rate differential between India and the US stands at 100bps which is considerably lower than historical levels as the Fed was much more aggressive than the RBI to raise rates.

So how will lowering rates by the Fed impact the Indian Market? According to the brokerage, a lower rate differential inter alia implies a lower premium for foreign investors and hence lesser foreign inflows. However, this does not seem to hold in relation to India. FPI inflows into India have remained buoyant, as India's growth momentum is expected to remain strong.

Furthermore, the BOB Economics report said, that while the Fed has already indicated that policy rates are likely to be reduced in the coming months, the growth and inflation dynamics in India suggest that RBI may just keep rates elevated for longer than that. In any case, the Fed is likely to cut interest rates much more than the RBI which will ensure that the interest rate differential settles somewhere close to the historical trend.

Moreover, Dr V K Vijayakumar, Chief Investment Strategist, at Geojit Financial Services said, the uncertainty regarding the Fed decision is over with the Fed keeping the rates unchanged and refraining from a hawkish message. The Fed chief's statement that "inflation has eased substantially while the labour market has remained strong" conveys conviction about the soft landing of the US economy and the possibility of probably three rate cuts this year. The response from the market was the US indices racing to record highs. This favourable global construct will have its positive impact on Indian markets too. The tug-of-war between FIIs and DIIs has been won by the DIIs for some time now. This trend will continue if the FIIs continue to sell, and, therefore, FIIs are likely to slow down their selling and may turn buyers. This will be positive for large-caps in banking, telecom, capital goods and automobiles.