Calls for an outsized rate cut are growing louder with 60% Wall Street traders predicting a 50 bps cut, according to CME FedWatch Tool. By the end 2024, markets are expecting a total reduction of at least 100 basis points in the first rate cut cycle in over 4 years since 2020.
But whether the Fed goes for 25 or 50, the biggest trigger for stock prices to move up or down would be Powell’s motivation behind the cut and the dot plot.
“If the Fed cuts because inflation has held off and growth is slowing down, but is not coming off a cliff, and it’s a slow and steady rate cut cycle, that would be good for equities. However, if the rate cut cycle is sharp in response to a recession, that’s not good for equities,” Shibani Sircar Kurian of Kotak Mutual Fund told ETMarkets.
She said if the Fed cuts 50 bps and says they need to do more and are worried about growth, then it would be a little worrisome.
On the other hand, if the Fed cuts interest rates and says it is also mindful of inflation, then it may be positive for the market.”That would mean that they believe growth is slowing, but there is a risk of inflation, which means growth is not falling off a cliff,” Kurian said.Ahead of the US presidential elections in November, the Fed is walking a tightrope. On one hand, they need to cut rates to support the economy, but they do not want inflation to come back.
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Dalal Street veteran Nilesh Shah reminds investors that the market has been wrong in predicting Fed’s movement since mid-2023.
“The first rate cut was expected in the middle of 2023 and my feeling is that this time also the market will be wrong in pricing or predicting the Fed. As of today, the Street is expecting four rate cuts, 25 bps in September, followed by 50 bps in November and 25 bps in December. Our feeling is that the actual rate cut by the Fed will be lower, far lower,” Shah said.
At the Jackson Hole Symposium last month, Powell had set the tone for the Fed meeting when he announced that the “time has come” for interest rate cuts as upside risks to inflation have come down.
What should investors do?
Rate cut cycle is good for equities but the previous three instances suggest otherwise. “In 2001, Nifty fell 35%; in 2007, it melted up initially, but plunged 60% in 2008; in 2019, it stayed flat,” Nuvama said, adding that expensive cyclicals (industrials, PSUs, autos, and metals) are the most vulnerable.
“Rate cuts usually lag an earnings slowdown. Essentially, EPS downgrades and weak growth outlook more than offset tailwinds from lower cost of capital. It’s only when rate cuts are deep (and valuations cheap) that they have a healing touch,” said Nuvama’s Prateek Parekh.
Given the strong domestic flows as well as macros, analysts say buying on dips can be a good strategy.
“Investors should accumulate large-cap stocks and ETFs tracking large cap indices such as Nifty 50 on dips. Expect some profit taking after the initial rate cuts are announced,” said Shrey Jain of discount brokerage SAS Online.
On the debt side, the most common advice is to buy long duration funds.
“Buy the longest possible maturity and sit tight on it. Rates will decline 6 months, 12 months, 18 months for the foreseeable future. And the duration which is the longest will give you the maximum return by virtue of capital appreciation. So, go for the longest possible duration and sit on it,” advices Shah.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)