The US Federal Reserve's March policy meeting was devoid of any surprises.
The Federal Open Market Committee (FOMC), responsible for setting interest rates in the United States, has voted unanimously to keep the rates unchanged. During a press conference, Fed Chair Jerome Powell hinted that a rate cut could come as early as June. The Fed dot plot, which shows FOMC members' future interest rate projections, confirmed the possibility of three rate cuts this year.
As a result of the Fed's decision, the value of the dollar index decreased, while the US yield curve steepened. This means that the difference between short-term and long-term interest rates has widened.
Veteran fund manager and co-founder of Pinetree Macro, Ritesh Jain, told Moneycontrol that both developments are good for Indian equities, especially high-beta cyclical stocks.
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Edited excerpt:
How do you view the FOMC policy?
The Federal Reserve decided to maintain the current interest rates without making any changes. However, they hinted at the possibility of reducing the rates thrice later this year. In my view, this move is aimed at boosting the economy, which is known as a reflationary policy. Despite the economy performing well and inflation showing no signs of slowing down, the idea is to retain the dots plot for 3 rate cuts in 2024. It is worth noting that this policy is primarily focused on the upcoming election in November. Recent economic data shows strong growth in employment and inflation expectations, yet the dot plot remains unaltered, and a highly accommodative press conference follows.
At the Press Conference, a question was asked, if financial conditions have loosened, which the Fed Chair did not even care to comment on properly. This signals that they are okay with it. So my reading of what they are trying to do is to extend the business cycle by keeping liquidity high and rates low. You can extend the business cycle by being dovish keeping financial conditions stable and saying that in May or June, you might be reducing QT (quantitative tightening).
At the same time, the dot plots for 2025 and 2026 have reduced, signalling that the Fed expects the neutral rate to be closer to 3.5% than 2.5-3%.
How will this Fed policy outcome impact global equities?
Fed is willing to overlook easing of financial conditions which means the risk-on rally can continue till either inflation gets out of hand or unemployment starts moving up sharply. We are now clearly in a late-cycle rally where cyclicals can take the leadership from tech.
How will this policy impact Indian markets?
DXY fell after the fed policy and the US yield curve steepened. A combination of these two is good for Indian equities, especially high-beta cyclicals. At this time the biggest risk to Indian markets is rising oil prices which will ironically get support from the falling US dollar.
How do you play when the market when economy is running hot?
The Fed has an inflation target of two percent but somewhere around 3 percent inflation, they will be even happy to cut. They want the business cycle to be elongated, meaning you want the economy to run hot, at a time when inflation expectations are up, oil has firmed up and China has stimulated a lot.
DXY has given up, bitcoin is up, silver is breaking out and gained 5 percent, and gold is at an all-time high. This has never happened, gold touching an all-time high on a Fed policy day! None of the tech stocks touched a new high today; it was the Dow that touched a new high. Industrials and infrastructure are clocking new highs.
Something different is happening. The baton is getting passed on from tech to cyclical. That’s what happens in late-stage expansion.
Even in India, the situation is the same: consumption is lower, banks are not doing well, and money is moving into cyclicals.
Till some time ago, the narrative was that the Fed would choose to err on the side of caution because they lost quite some credibility after they allowed inflation to get entrenched earlier. Why would they not care about it? Inflation is equally a political issue.
They have kept the options open. If oil remains where it is, then inflation won’t go up too much, so they will get a chance to cut the rates. They will have a nominal GDP of 7-8% going into the elections, they could have a 5l500 or 6,000 S&P 500 going into the elections. People vote based on what has happened to them in the last three to six months in any country. If their home prices are higher and their asset prices are higher, they will vote for the person who has done it for them.
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Powell commented on house rentals saying it is high but year-on-year it is coming down. He is saying, it's okay. They are okay with the economy running a bit hot and financial conditions easing right now. That’s why the dollar sold off, and the yield curve steepened.
What to watch going forward?
Inflation and unemployment in the US. Fed also hinted at QT tapering soon. This could help with releasing liquidity in the economy exactly at the time when bank reserves are shrinking.
I believe that over the next few months, inflation will prove to be sticky and the employment picture less than robust. We will cross the bridge when we come to it.
US long bond yield could come under significant pressure over the next few months leading to steepening of the yield curve.
What will be the key global risks to watch?
Rising oil prices will feed into inflation.
What is the overall risk/return tradeoff?
For the near-term, it is a green light for risk assets to rally but the more risk assets rally the more the Fed will find it difficult to cut rates.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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