US CPI cools, Fed Chair hints at rate cuts; what should investors’ strategy be?

The Indian stock market benchmarks posted healthy gains on Friday, July 12, as investor risk appetite increased on hopes that the US Federal Reserve was nearing the start of a rate cut cycle.

The hope was fuelled after the June inflation data came slower than expected.

Cooling for the third consecutive month, the US consumer price index (CPI) dropped 0.1 per cent month-on-month in June against the expectations of a 0.1 per cent rise. Year-on-year, the CPI rose 3 per cent against the expectations of 3.1 per cent and compared to 3.3 per cent in May.

Meanwhile, Federal Reserve Chair Jerome Powell, in his testimony in the House of Representatives, said the US central bank will cut interest rates when and as needed based on the economic data and evolving outlook.

Experts believe the US central bank may cut rates in its September meet even before inflation reaches its 2 per cent target.

"The Fed is likely to begin rate cuts in September due to easing inflationary pressures and a softening labour market. Fed Chair’s Congressional testimony highlighted that the Fed may cut rates even before inflation reaches the 2 per cent target," said Rajani Sinha, chief economist at CareEdge Ratings.

Sinha underscored that the US CPI inflation fell for the third straight month in June and an expected moderation in shelter prices should further aid inflation’s gradual descent towards the 2 per cent target.

Moreover, while the labour market remains tighter than pre-pandemic levels, there has been some softening, with fewer nonfarm payroll additions and an uptick in the unemployment rate.

"We expect the Fed to reduce rates by 50bps in 2024, starting with a 25bps reduction in September followed by another 25bps cut in December," Sinha said.

Sujan Hajra, chief economist at Anand Rathi Shares and StockBrokers, also expects the US Federal Reserve to initiate the rate reduction cycle in September 2024.

What should investors' strategy be?

Experts believe markets might have discounted the possibility of a rate cut in September to a fair extent. If the actual rate cut aligns with market expectations, it may not significantly impact market sentiment.

"The Fed Fund rates indicate that the financial markets have already factored in a potential rate cut in September 2024 with approximately 60 per cent probability. Currently, the market seems to be pricing rate cuts amounting to 65-75 basis points for 2024," said Hajra.

"These expectations are dynamic and evolve with new data and events, including comments from policymakers, which are reflected in financial asset prices. As long as the Federal Reserve's actions align with market expectations, the actual rate cuts are unlikely to significantly impact market behaviour and sentiment," Hajra said.

Experts say investors should focus less on the Fed and more on the market fundamentals. Moreover, one's risk appetite and financial goals are the factors that should decide one's investment strategies.

"For long-term wealth creation with high levels of predictability, we advise investors to make strategic long-term asset allocations based on personal preferences, considering factors such as realistic asset return expectations, risk tolerance, and investment horizon," said Hajra.

Besides, asset allocation remains a crucial factor. Considering the current market conditions, experts advise giving more preference to large-cap stocks.

"Numerous studies have demonstrated that asset allocation alone accounts for approximately 90 per cent of the variability in long-term portfolio returns. In contrast, specific financial instrument selection within an asset class or market timing typically impacts less than 7 per cent of long-term portfolio performance," said Hajra.

"We do not recommend making significant portfolio changes based on the Federal Reserve’s monetary policy expectations. Investors should consider staggering fresh investments in the Indian equity market and maintain a slight preference for large-cap equities over mid-cap equities," Hajra said.

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Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.