Street awaits US Federal Reserve's first interest rate cut in 4 years

By the time the next edition of Business Standard hits stands, the US Federal Reserve (Fed) may have lowered interest rates for the first time in four years.

To cool inflation, the US central bank raised rates 11 times between March 2022 and July 2023. After its last rate hike of 25 basis points (bps) in July 2023, pushing rates to 5.25-5.5 per cent, a 23-year high, the Fed has held rates steady.

Last week, US markets, along with domestic equities, rallied sharply as expectations shifted from a conventional 25-bp cut to a more aggressive 50-bp cut. Optimism was driven by recent US economic data showing a slowdown in the labour market and cooling inflation.

Experts caution that market reactions to the impending interest rate decision remain uncertain. While a larger cut would typically boost equities, it could also raise concerns about the economy’s health, potentially dampening sentiment.

Conversely, a 25-bp cut might disappoint markets that have priced in a more substantial reduction. In the medium term, the policy trajectory, guided by incoming data, will dictate market direction.

History suggests that the start of a rate-cut cycle alone is not a reliable trigger for market rallies.

“By using history as a guide, we found that equity market behaviour after the Fed starts cutting rates varies depending on economic conditions,” said Chris Galipeau, senior market strategist (equities) at Franklin Templeton Institute.

“The Fed’s decisions have a global impact, and we believe many other central banks will follow suit. Our analysis of historical global equity performance in the 12 months after the Fed’s first rate cut shows that equity markets tend to perform well when rate cuts are not followed by a recession,” he added.

An analysis by Nomura of the past six Fed rate-cut cycles revealed muted performance in both Indian and US markets during the previous cycle. The Nifty gained 4.5 per cent and 1.1 per cent three months and 12 months after the first rate cut on July 30, 2019. Meanwhile, the US S&P 500 rose 1 per cent in three months and 8.1 per cent in one year. Nomura concluded that the economic conditions necessitating rate cuts and the starting valuations at the onset of these cycles hold the key to market performance.