MC Explains: Why Fed took a dovish stance and what it means for Indian markets

Fed chairman Jerome Powell. The Fed held rates steady but dropped enough hints that rates could be cut in 2024.

The US Federal Reserve on December 13 left the benchmark federal funds rate unchanged at 5.25-5.50 percent but signalled that it was done with the hikes and rates could be cut in 2024 and beyond.

Through this explainer, we try to decode the reasons for the move and its implications for the Indian markets.

Why is the market so excited? After all it was expecting the Fed to cut rates in 2024

What has changed is the Fed tacitly acknowledging that rate cuts could be a possibility in 2024. Barely a few weeks back, Fed chair Jerome Powell had said it would be “premature” to speculate on the timing of rate cuts.

How much will the Fed cut rates by?

Too early to say. Rate projections by Fed officials point to a cut of 75 basis points by the end of 2024, a sharper pace of cuts than indicated in September. Median expectation for the federal funds rate at the end of 2024 was 4.6 percent but individuals’ expectations varied widely.

Why the about turn in the Fed stance after saying until recently that rates could stay higher for longer?

Inflation has fallen sharply and is now not very far from the Fed’s 2 percent target. Job market is showing signs of cooling, or at least is not as tight as it was till some months back. The Fed now appears confident that it can push inflation lower without having to resort to more rate hikes. There could also be a view in the Fed that keeping rates higher for longer could be counterproductive if it leads to job losses.

Also read: Bulls all charged up as Fed signals rate cuts earlier than expected

Is there a possibility of the Fed hiking rates?

For now, it appears to be slim. Because none of the rate projections by Fed officials indicate an increase. The Federal Open Market Committee (FOMC) statement says that officials will consider the extent of “any” additional policy firming that’s needed.

What does it mean for India?

Lower interest rates on US government bonds means more money available for risk assets like emerging market equities. Given India’s strong macroeconomic fundamentals, it is the best placed among emerging markets. Also, lower interest rates in the US means a weaker dollar, and by corollary a strong rupee. Good for India’s exports as well as our import bills.

Also read: Sensex, Nifty hit record highs on Fed's dovish pitch, analysts expect largecaps to finally get going

Will the RBI cut rates any time soon?

There is a strong possibility that the Reserve Bank of India (RBI) will follow suit if the Fed cuts rates. The majority view is that the RBI will not cut rates ahead of the Fed because that could put pressure on rupee.

How soon is the Fed likely to cut rates?

Federal funds futures markets are now pricing in six rate cuts for next year, up from four earlier this week, and traders have fully priced in a rate cut in the Fed’s March meeting, according to a Bloomberg report.

What does the rate cut mean for the India’s IT sector?

A positive development on the face of it. The biggest worry, so far, was that the US economy may slip into a recession because of high interest rates. Those fears have reduced significantly, and the street now expects outsourcing order flows from US to gather pace. What is also working in favour of Indian IT stocks is that institutional exposure is much lower than what it was during 2021-22.