Fed Rate Cut On The Horizon — Here's How Indian Market Is Poised To Ride The Wave

The wait is finally over, as the US Federal Reserve is all set to cut interest rates for the first time in four years. However, history suggests that this move may not bode well for Indian stocks.

India's stock market is on course for its longest bull run in two decades, according to Bloomberg. Foreign inflows might weigh on this run like previous instances, when the US central bank cuts interest rates after long pause.

Global funds have pulled off money from India in the immediate one to three months following the commencement of rate cuts in the US, in three out of four such instances. "The key driver of short-term outflows is usually global risk-off scenarios," Citi had said earlier.

This time around, the probability of a half-point cut is increasing despite a slight uptick in August inflation, as Jerome Powell looks to engineer a soft landing for the economy. Key indicators have already hinted that the world's largest economy is too late to cut rate, as recessions has already began.

Fed funds futures traders on Tuesday priced in a 67% probability of a 50 basis-point cut, up from 47% last Friday. They saw a 33% probability of a 25 basis-point cut, according to the CME FedWatch Tool. 

Going into the Fed's crucial decision, overseas investors have been bullish after a lull in August. So far in September, foreign investors have pumped in Rs 27,856 crore in domestic equities with over 90% of it in the secondary market unlike the previous months, according to data from National Securities Depository Ltd. Government bonds have seen inflows of Rs 22,380 crore so far this month.

The US central bank will begin its two-day meeting starting Tuesday with the chair set to announce the crucial decision on Wednesday.

A Fed rate cut of 25 basis points might instill fear in the markets, according to Andrew Holland, chief executive officer of Avendus Capital Public Markets Alternate Strategies. He hopes for a rate cut of 50 basis points.

“For the Fed, it’s really about whether it’s 25 or 50 (basis points cut), and the narrative around what it’s saying about ongoing rate reductions. I hope it goes around 50 bps, and given the kind of interest rate cycle we are in, I think that’s what the markets would like as well," he told NDTV Profit.

Fed cutting rates will increase capital flows to emerging markets, Nilesh Shah, managing director, Kotak Mutual Fund told NDTV Profit. The cut should benefit India as it holds the highest weightage. The expected move will support gold prices and the bull run should continue, he said.

Over a 12-month period, after the rate cuts commenced, flows were positive in all cases as dollar weakness aided. "There has been USD depreciation in the recent past as well," Citi said.

The valuation at which domestic stocks are quoted might potentially hinder equity inflows. India remains the most expensive emerging market in the run up to the Fed decision.

The mid-cap benchmark is valued over Nifty 50 and the small-cap stocks continue to gain more despite froth concerns. The price-to-earnings ratio of the Nifty is valued at 24.4, while that of the small-cap and the mid-cap index is at 33.6 and 45.8, respectively.

Fed will start cutting rates and strong momentum in domestic markets have turned foreign investors to net buyers, according to V K Vijayakumar, chief investment strategist, Geojit Financial Services Ltd. "High valuations in India, however, continue to be a concern."

Domestic inflows that have been powering India's stock market may see a short-term pause after having pumped up valuations, according to Jefferies strategists. The brokerage expects foreign flows to provide a cushion to domestic flows that may take a breather.

"The unsustainably high flows from domestic retail investors and institutions into stocks make us uncomfortable on the near-term equity outlook."

January-August shows that the combined domestic flows through mutual funds, direct participation, insurance and pension funds are averaging at $7.5 billion per month, Jefferies said.

India's benchmark indices—the NSE Nifty 50 and the S&P BSE Sensex—have risen 16.3% and 14.3% respectively so far this year, making them the fifth and sixth best-performing Asian indices.

This is the time to move from low floating stocks with concentrated holdings and expensive valuations to high floating stocks that have market discovered prices and reasonable valuations, according to Nilesh Shah. "We will see stock specific movement."