Fed cut to boost market sentiment; may positively impact rupee

The Fed cut rates by 25 basis points in July for the first time in 11 years, but comments from Powell’s rate cut was for a “midcycle adjustment” and not a start of an interest rate cutting cycle. However, we strongly believe that the Fed may move with a 25 basis-point cut in September and change its stance from ‘neutral’ to ‘dovish’. The reasons behind a 25 bps cut in July remains intact such as US-China tariff war, slowdown in the Eurozone economy and mixed economic data from the US book.

The US economy is showing mixed signals as job growth remains robust but the industrial activity is slowing down. A lot of Federal Reserve moves depend on the following three factors:-

(1) The upcoming US economic data,
(2) The final shape of the US-China trade war, and
(3) Britain's exit from the EU and its cascading impact on other economies

Impact on Indian financial markets if Fed cuts interest rate:

Theoretically, a rate cut in the US should be positive for developing economies such as India, which have higher inflation and, thereby, higher interest rates in comparison to developed economies such as the US and Europe.

As a result, FII’s could borrow money in the US at low-interest rates in dollar terms, and then invest that money in bonds of Indian rupee denomination to earn a higher rate of interest. The US dollar may fall against a basket of major currencies and is expected to give a boost to the rupee, which will appreciate amidst strong foreign capital inflows. The Indian rupee, which has dropped to the lowest level of 2019, may consolidate for a while. As foreign fund inflows improve, the rupee may appreciate from current levels.

We have observed that the stock market's reaction to any change in interest rates is generally immediate, while the economy takes about 10-12 months to see any widespread effect. A decrease in interest rates by the Fed will have a significant effect on the Indian stock market which is highly valued among other emerging markets.

Fund flows will improve and help the equity markets to rally. In recent months, central banks of China, Malaysia, South Korea, Indonesia and the Philippines have opted for accommodating measures and India is also following suit. Once the Fed decreases the interest rate, RBI moves on a similar line and decreases the interest rate to maintain the difference between two nation’s interest rates.

There is enough room for the RBI for further cut rates. RBI has cut the repo rate and reserve repo rate by 35 basis points (bps) respectively on August 8 and this is the fourth time in a row. The current repo rate is at 5.4 percent and reverse repo rate is around 5.15 percent, while the RBI expects the inflation to remain well within the central bank's comfortable 4 percent target range.

Lower interest rates are termed to be catalysts for growth. Personal and corporate borrowing improves which leads to robust growth in the economy, consumer spending and also an increase in housing sales. Businesses will get cheaper loans and sales will increase due to an improvement in demand, higher turnover, and profitability, which will eventually lead to a rally in stock prices.

(The author is Chairman at Abans Group.)

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