About two-third traders on Wall Street are pricing in the chances of a 50 bps cut on Wednesday and a total of 100 bps rate reduction by the end of December 2024. But the market has a history of being wrong when it comes to predicting the mood of the rate-setting panel Federal Open Market Committee (FOMC).
In case Powell cuts rates by 25 bps but says it will not let the ugly head of inflation rise again, then it may be positive for the market. But if the Fed cuts drastically by 50 bps and says they need to do more and are worried about growth, it could lead to a stress in stock prices as investors may take it as a signal of the US economy tipping into recession.
On one hand, the Fed needs to cut rates to support the economy, but they also don’t want inflation to come back.
Also read | US Fed meeting begins. Does the stock market need a 25 or 50 bps rate cut?
“They will sell two different things to two different constituents. To fixed income guys, they will say inflation is coming down and hence, I am cutting rates. And to the equity market, they would not like to convey that because the economy is slowing down, I am cutting rates,” Nilesh Shah, MD of Kotak Mahindra Mutual Fund told ETMarkets.
When asked to comment on the quantum of Fed rate cuts, he said the actual rate will be far lower than what the market is predicting.
An ideal and possible outcome would be a 25 bps rate cut with a dovish message, indicating a series of rate cuts, analysts said.
As the rate cut cycle begins, Dalal Street’s top stock picker S Naren of ICICI Prudential Mutual Fund said the ideal strategy is to focus on asset allocation.
“A rate cut typically signals a slowing economy, which means equity earnings may not grow significantly. This is why it’s crucial to have no leverage and limit excess risk in your portfolio. Instead, focus on investing in quality stocks—quality-oriented value rather than aggressive value stocks,” he said.
Additionally, he said one should avoid leverage — or, if one has taken on leveraged stocks, reduce them to zero and book profits.
In the last three decades, Fed has announced a 50bps rate cut 10 times, which has resulted in a median return of 1.6% for Nifty, shows a study by Capitalmind.
“A 25bps cut has been followed by a more modest -0.5% median Nifty return. There are outliers as well, for example, the nearly 7% drop in October 2008 following a 50bps cut in the middle of the global meltdown during the global financial crisis,” Capitalmind said.
Lower rates can also lead to higher inflows from foreign investors. Ahead of the rate cut cycle, FIIs have already invested Rs 31,000 crore on Dalal Street so far in the month.
Investors believe that rate cuts would be positive for banks and NBFCs.
“Rate cuts could lead to a good amount of treasury profits on the investment book of the banks. They are the cheapest sector (relative to history) in the entire market at this point. So I believe rate cuts would give a positive benefit to banks and NBFCs. They can help them with their borrowing costs as well. This is how we look at it at this point,” Naren said.
In the meantime, the Street is also expecting the RBI to cut rates by at least 25 bps by December.
“Why should the RBI hurry? India is the fastest growing major economy. Inflation is coming down and will be below 4%, but overall inflation will be between 4% to 6%, which is the higher end of RBI’s target range. The rupee is stable. Foreign inflows are happening in the debt market. There is no need for RBI to immediately follow the Fed. It has all the time in the world to hit the ball whenever they decide to hit,” Kotak’s Nilesh Shah said.
Also read | As stock market is shifting from value to quality, how S Naren is investing
