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How your investments will be impacted by US Fed's interest rate cut

Global capital flows to emerging markets likely to improve when there are fears of a recession. Most experts prefer to play along with the central bankers and that explains the new stock market adage—‘Don’t fight the Fed’.

, ET Bureau|
Updated: Nov 04, 2019, 07.36 AM IST
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Rate reduction and balance sheet expansion by US Fed is good news for India.
Market movements were probably easier to understand in the past. Investors would buy equity when the economy was on expansion mode and switch to government debt when the economy was in trouble. However, it’s not so simple any more. Preemptive actions by global central bankers like the US Federal Reserve aimed at preventing recession have complicated matters. Investors are now forced to second guess what the central bankers are likely to do. Most experts prefer to play along with the central bankers and that explains the new stock market adage—‘Don’t fight the Fed’.

Efforts by global central bankers to fight recession are ongoing. For instance, the US Fed reduced interest rates by 25 basis points on 30 October, the third such cut this year (see chart). More importantly, the US Fed has also started bolstering its balance sheet by way of quantitative easing to fight recession fears, after years of balance sheet reduction. The balance sheet increase will see the US Fed increasing dollar supply through the banking system. In addition to the balance sheet increase by the US Fed, the US government is also on an expansion spree and its budget deficit in 2019 has zoomed to $ 984 billion, the highest in the last 7 years.

Latest Fed rate cut was third this year
Rate reduction and balance sheet expansion by US Fed is good news for India.
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Source: Bloomberg


Similar actions are expected from other central bankers too. “Interest rates in Japan, Europe, etc are close to zero and therefore, the scope rate action is limited. So be ready for more quantitative easing,” says Kishore Narne, Associate Director, Motilal Oswal Financial Services. How will these actions impact your investments?

Equity markets bullish
After the latest Fed rate action, US stocks have shot up to new all-time highs and equity investors are enjoying a Goldilocks economic situation. This is a time of moderate economic growth and low inflation, which leads to a market-friendly monetary policy being introduced by central banks. Due to increased global inflows, its impact will be more pronounced on emerging markets like India. The Sensex hit a new all-time high on 31 October. “Within emerging markets, countries like India will attract higher inflows because of higher growth rate and lower inflation,” says Narne. Please note that although the GDP growth rate has come down, India is still one of the fastest growing economies in the world.

This Goldilocks situation is expected to continue for some more time because the US recession—if it were to happen—is still at least 12 months away. However, equity investors should be careful and should watch data points carefully to make sure that the economic situation does not deteriorate further from current levels. “It is good for us if the US economy is not very strong nor very weak. In the event of recession, investors will get back to risk off mode and money will start flowing back to US treasuries,” says Jyotivardhan Jaipuria, Founder and Managing Director, Valentis Advisors. Mayur Patel, Principal Fund Manager, IIFL AMC concurs with this view. “Global flow to emerging markets like India will continue to improve when there is a fear of recession and not actual recession. Investors should take necessary actions once they are sure about a recession,” he says.

Good news for bullion too
Central government actions are complicating the outlook towards bullion too. Traditionally, bullion is a hedge against inflation and therefore, moves up in high inflationary periods (usually during boom time) and falls in low inflationary periods (usually during recession).

However, gold is also an international currency and therefore, its price will move up if other currencies depreciate. This means the continued printing of currency by global central bankers and the resultant weakening of the dollar is good news for gold investors. In addition to a weakening dollar, geo political issues like the trade war between US and China, the skirmish between Saudi Arabia and Iran and the Turkish invasion of Syria are also pushing up prices of gold.

Despite the recent rally, experts say that it is still worth looking at gold. “We expect international gold to reach $1,680 within the next 12 months due to a weakening dollar and geo political issues. Most of this gain will accrue to Indian investors also because rupee will not appreciate significantly due to domestic problems,” says Narne. So why will the rupee not appreciate if the dollar is depreciating? “Dollar weakening and rupee strength is not directly co-related. Despite weakness in dollar, rupee will not appreciate much because most parameters supporting the domestic economy has weakened of late,” says Arun Singh, Chief Economist, Dun & Bradstreet India. Since inflation is down and is not a threat now, the RBI is also expected to temper rupee appreciation to support India’s exports.

Debt market will also benefit
The domestic debt market is also expected to benefit. The downward pressure on the rupee was one of the reasons behind the recent rise in yields of long-term bonds. A weakening dollar will now remove this threat. Bond prices and yields have an inverse relationship. Inflation is under control now. However, it could have gone up if the rupee continued to remain weak. This means the domestic yield should come down if the outlook is stable and the chances of rate cuts increase further. This is line with the long term trend also.

“Structurally, interest rates have to come down because Indian rates are still very high compared to global levels. Instead of trying to time the markets based on news flows, investors should go with dynamic funds,” says Lakshmi Iyer, Head of Fixed Income and Product, Kotak AMC.

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