What Does The US Fed's Interest Rate Cut Mean For Indian Investors?

Federal Reserve Chairperson Jerome Powell indicated there's more to come at a press conference after the benchmark policy rate was reduced to the 4.75-5 percent range.

Will RBI follow the Fed rate cut?

The Federal Reserve's recent 50 basis points rate cut may make the Reserve Bank of India (RBI) to consider a similar move. India's retail inflation rate has eased to 3.65% year-on-year in August 2024, marking a nearly five-year low. This strengthens the case for a potential rate cut in October, as the central bank wanted to bring down the inflation rate to the medium-term 4% target on a durable basis.

However, RBIs focus will remain on managing inflation during the festive season while maintaining growth. Nonetheless, a swift shift in its policy stance cannot be ruled out.

What does Fed rate cut mean for Indian investors?

Foreign investors have injected nearly Rs 33,700 crore in Indian equities so far this month, driven primarily by interest rate cut in the US and the resilience of the Indian market. This also marks the second highest inflow in a month this year so far, the last one being in March when Foreign Portfolio Investors (FPIs) infused Rs 35,100 crore, data with the depositories showed.

The weakening US dollar and the dovish stance of the Federal Reserve are making Indian equities increasingly attractive to investors. The rupee's strengthening reflects confidence in India's stability, although it could challenge the export sector. Additionally, balanced fiscal deficits, the impact of rate cut on the Indian currency, strong valuations, and RBI's approach to keeping inflation under control without a rate cut are the primary factors for making emerging markets like India a sweet spot.

Coming to the debt markets, bond yields usually move in anticipation of interest rate changes. Over the past year, India’s 10-year bond yield has been on a downward trend, falling from 7.1 percent to around 6.85 percent level this week.

We expect the 10-year yield to drift towards 6.75 percent after September, with a year-end target of around 6.55 percent.

How will falling yields impact bond mutual funds?

Bond prices and yields have an inverse relationship. When yields fall, the prices of bonds typically rise. Since debt mutual funds hold a portfolio of bonds, the net asset value (NAV) of the fund usually increases as bond prices go up.

Though bond funds have made good gains over the last year, we anticipate another leg of the rally. The overall situation remains bond-positive, with a clear expectation of rate cuts and a favorable demand-supply situation. Amid global monetary easing, Indian bonds continue to be attractive, supported by robust and stable macroeconomic fundamentals and favorable demand-supply dynamics.

Our Take

The Fed’s rate decision is expected to lower borrowing costs, stimulating economic activity and boosting Indian bond prices, especially long-duration bonds, as yields fall.

This could lead to a global rally in debt markets, improving liquidity and making it cheaper for businesses and consumers to borrow. The rate cut is also expected to weaken the dollar, increasing foreign demand for US bonds.

Interest rates often influence fixed deposit (FD) rates. When central banks adjust interest rates, banks typically respond by changing the rates they offer on fixed deposits. When interest rates rise, FD rates are usually hiked to attract more deposits. Conversely, when rates are cut, FD rates may decrease, too. Individual banks, however, may also consider factors such as competition and their funding needs when setting rates.

Long-duration strategies are highly sensitive to interest rate changes, meaning they will benefit significantly from falling yields as bond prices rise. This provides potential for capital appreciation, making them attractive in a declining interest rate environment.

Considering the recent developments of the Israel conflict and the current market run-up, equities could turn volatile from here. From a risk-reward perspective, if the goal is to maximize returns post-rate cut, long-duration bonds offer better prospects for capital appreciation, but careful consideration must be given to your risk appetite, liquidity requirements and fund selection after evaluating with your investment professionals.