US Fed rate cut: The outcome of the September policy meeting of the Federal Open Market Committee (FOMC) could be the most significant catalyst for global markets—or perhaps not.
Although no one knows what the US Federal Reserve will decide about policy rates on September 17-18, there is still prevailing certainty that the rates will be trimmed.
Rate cuts are generally good news for the market. However, this time, it's not just the rate cut itself, but the size of the cut that will likely swing the market.
Speculations are high about the Fed's possible move. Most experts believe the Fed will cut the rate by 25 bps. However, a few believe the central bank may go for a bigger cut of 50 bps.
The market has largely priced in a 25 bps rate cut. If the Fed meets this expectation, the market response may be muted.
A section of experts believes a 50 bps cut could boost market sentiment. However, the counterargument is that a deeper rate cut might also signal severe stress in the US economy, potentially leading to a negative market reaction.
Mint spoke with several experts to gain their insights on the Fed's policy move and its impact on the Indian stock market. Here's what they said:
A 50-bps rate cut by the Federal Reserve in September 2024 is possible, though unlikely.
While some recent data, particularly related to the labour market, has underperformed expectations, it’s not yet enough to suggest a significant deterioration in economic conditions.
The Fed would likely only opt for an aggressive cut if the economic outlook worsens considerably.
For now, the situation appears relatively balanced, which makes it less probable for the Fed to frontload a rate cut of that magnitude.
There is a notable divergence between the Fed’s guidance and market expectations on rate cuts.
While the market seems to be anticipating a frontloaded cut, the Fed appears to signal a more gradual, but eventually deeper, easing.
A 25 bps cut could disappoint some market participants who expect more aggressive action.
However, a bigger cut, like 50 bps, could trigger a more negative reaction as it might be interpreted as the Fed signalling greater concerns about the economic outlook.
On balance, a 25-bps cut is likely to be the least disruptive for global financial markets.
Most macro indicators point to a normalising trend rather than a slowdown trend.
Particularly, if we look at labour market data, which the Fed looks at closely, it is still in addition (not in a decline that we would correlate in recession).
Unemployment at 4.2 per cent declined by 4.3 per cent in the previous month, and wage growth was 3.8 per cent again higher than the previous month.
Therefore, many of the indicators, such as retail sales, the consumer confidence index, and the services PMI, are still positive.
So, pockets of slowdown cannot be attributed to a broad-based slowdown. The Fed will likely consider these indicators in totality and opt for a 25 bp rate cut.
Overall, a 25 bp rate cut should not be disappointing as it is the base case, with a 71 per cent probability.
The language and direction of the future rate cut will be more important to watch as the market is still aggressive on the pace of rate cuts (cut in every policy with weights for more than 25 bp cut) and overall four-to-five cuts in the next three policies.
This expectation may disappoint if the Fed gives a guarded answer on future rate cuts.
Fed rate actions should be more of an indication of how the central bank thinks of the fundamental state of the economy.
An aggressive cut is not an indication of rejoicing but rather the contrary, as the central bank believes the economy is weakening significantly, which is not positive for growth.
Therefore, a measured and balanced cut is a sign of normalisation, which should bring cheer.
Furthermore, for Indian investors, fundamentals do take precedence as the domestic growth story is well in place. Fed actions are more of external risks, but India’s central bank, RBI, has been vigilant and adept at navigating external shocks.
A rate cut of 25bps is already priced in by the markets. Therefore, a rate cut on the same lines may not have any immediate price impact as such.
However, if the cut is to the extent of 50 bps, then it will have a greater price impact on the markets.
In either case, the market will read into the action that the Fed policy has turned around and that more rate cuts will follow soon.
A second and more important impact of the rate cut is that it will lead the market to conclude that a slowdown is gradually taking grip on the US economy.
While the first situation will result in a fall in the market yields, the second one will have consequences for US dollar-denominated asset markets, especially the US equities.
According to the CME Fed Watch Tool, which tracks market expectations for rate cuts, there is a 71 per cent probability of a 25 bps rate cut.
However, with US job data falling short of expectations for the second consecutive time, the Federal Reserve may even consider a 50 bps cut to help stimulate the slowing economy.
A 50 bps rate cut would indicate that the US economy is slowing and the Fed is aiming to stay ahead of potential challenges.
However, a larger rate cut doesn’t necessarily guarantee a market rally.
Historically, significant rate cuts have not always been perceived positively and could trigger further sell-offs. In comparison, a 25 bps rate cut is widely expected and already priced in, so we anticipate limited market reaction following the announcement.
The market is giving a 50 per cent chance of a 50 bps rate cut in the September meeting.
The probability of a 50 bps rate cut, as indicated by the US interest rate futures, has risen after the weakness in US job numbers.
Thus, chances have increased, but there is still a 50:50 probability of a 25 bps versus 50 bps rate cut.
Since the probability is evenly balanced between both these scenarios, it will be difficult to comment on how the markets will react to the Fed's decision.
If the August inflation number is below 2.9 per cent, the chances of a 50 bps rate cut might increase.
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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.
