US Fed rate cut: How does it affect the Indian stock market and your wallet?

The 800-pound gorilla just woke up the stock markets! We are talking about the US Federal Reserve’s decision to cut rates by half a percentage point (50 basis points) to 4.75% – 5.0% for the first time in 4 years, thus kicking off its monetary easing cycle. (One basis point is 0.01% or (1/100th of a percent). 

But wait, the impact is not as bad as it might seem from the above line. In fact, till now, it’s positive, especially for the Indian stock market as benchmark indices Nifty, Sensex climbed to a record high on September 19, buoyed by expectations of a rise in foreign inflows after Fed rate reduction announcement. And the rally is still going strong.

Before we jump the gun to cheer the good start, let’s take a closer look at the Fed’s rate cut decision and how it affects you and me.

Firstly, what is a Fed rate cut?

So, Fed controls something called the “federal funds rate.” This is essentially the interest rate at which banks lend money to each other overnight. This is similar to the Reserve Bank of India (RBI)’s repo rate. Here, it is the rate at which RBI lends money to commercial banks against government securities. 

Now, let’s get back to the Fed funds rate. The exercise of banks lending money to each other has a domino effect on a ton of things, from the interest you pay on credit cards to the returns you get on your savings account. When the Fed cuts rates, it makes borrowing cheaper, which they hope will get people and businesses spending more. 

Why did the Fed cut rates this time?

To answer this question, we need to understand the state of jobs in the US market.

The US unemployment scenario was fuelled by the COVID-19 pandemic in 2020 and has been on a worrying trend since then. Remember when April 2020 saw the unemployment rate skyrocketed to 14.7%, the highest level since the Great Depression? 

To offset this insane rise in unemployment, the US government announced various stimulus bills fuelling roughly $5 trillion to the public, the local governments, airlines, hospitals, and other institutions.

This unleashed the largest flood of federal money in US history as more money was available to businesses, increasing the demand for jobs. But, then came another problem: more vacancies, less applications. In fact, between mid-2021 and early 2022, the ratio of job vacancies to unemployed workers doubled.

Impact on Inflation

With high joblessness, supply-chain disruptions, massive stimulus relief packages to the citizens, the US inflation took a big hit. The index surged to a 40-year high of 9.1% in mid-2022, forcing the Fed to hike interest rates 11 times between March 2022 and July 2023 to cool down inflation and bring it in the 2% target. 

The high interest rate ultimately led to cost-cutting, slowdown in growth and historically high layoffs and then, another cycle of unemployment began.

Now, the unemployment rate stands at 4.2% as per August 2024 labour data, which is a slight improvement from the near 3-year high of 4.3% in July. But this is still a cause of concern, based on the so-called Sahm Rule. 

Named for former Fed economist Claudia Sahm, the rule states that a recession is almost always underway if the three-month average unemployment rate rises by half a percentage point from its low of the past year. It’s been triggered in every US recession since 1970.

To summarise, the Fed decided to cut rates because the US economy had shown signs of slowing down, so much so, that many economists feared that the country is on the brink of a recession due to rise in the unemployment rate.

How does the Fed rate cut affect Indian stock market?

Two words: Ripple effect. While the Fed rate cut primarily impacts the US economy, its ripple effects can reach Indian shores. Let’s break it down:

Rise in foreign inflows: Dalal Street is taking the 50 bps rate cut as a “positive surprise” as it expects increased foreign inflows due to lower rates in the US, thus bringing higher returns. According to reports, policymakers expect the Fed’s benchmark to fall another half of a percentage point by 2024-end, and another one percent in 2025.

Investment Opportunities: If you’ve been waiting to invest in stocks, this might be a good time to dip your toes in. A positive sentiment in the markets could create some attractive entry points for long-term gains. Just remember to do your homework and pick stocks that align with your financial goals.

If you are interested in investing, here are some smallcases you can explore.
Health warning: Markets don’t always behave predictably!

Impact on Rupee: A rate cut in the US can lead to a stronger dollar, potentially weakening the Indian rupee. This may increase the cost of imports, making goods like electronics and oil more expensive for us.

Impact on Exports: A stronger dollar can make Indian exports, such as textiles and IT services, more expensive for US customers, potentially affecting demand.

Now, for you

Apart from investing in stock markets, let’s talk about how this affects your personal finances:

Debt Repayment: If you have loans, the interest rate environment might work in your favour. Even though this cut doesn’t directly affect Indian interest rates, as RBI monitors the repo rate here, it could lead to banks lowering their lending rates over time. Keep an eye on your bank’s offerings; you might want to refinance if rates drop.

Inflation Watch: Lower rates in the U.S. can sometimes lead to inflationary pressures globally. If inflation rises, your purchasing power could take a hit. It’s smart to keep a budget in check and make adjustments as necessary.

Will RBI follow suit?

While there’s no direct correlation between Fed and RBI rate cuts, the Indian central bank closely monitors global economic trends. RBI has left the repo rate unchanged at 6.50% since February 2023 as it tackled to bring down inflation. But a rate cut right after Fed’s decision seems unlikely at this point. 

According to an SBI Research report, a rate cut from the RBI is unlikely this year, with a potential announcement expected only in February 2025. RBI Monetary Policy Committee is scheduled to meet from October 7-9, where it would discuss interest rate matters.

To wrap it up

The Fed’s rate cut in September is surely something to watch in the long term and how global economies react. While it can bring optimism to the Indian stock markets and create potential opportunities for you, it’s essential to remain cautious and informed. Remember, investing is a marathon, not a sprint, so always be prepared.