-By Karan Singh and
Saksham Mangal
Introduction
Finally, the Federal Reserve officially announced its 3rd consecutive interest rate cut of 2024 on Wednesday in its press release. Fed has reduced interest rates by 25 bps making it in the target range of 4.25%-4.50% from the previous target range which was 4.50% to 4.75%. When the Federal Reserve changes its interest rate it leads to significant changes in the global financial systems. But before diving deep into this, let's quickly understand what is ‘BPS’. Bps refers to basis points and 1 basis point is equal to 0.01% thus the rate cut by 25 basis points means that the interest rate is reduced by 0.25%.
Why did the Fed cut interest rates?
Now let’s understand in detail why the Fed is cutting interest rates continuously in 2024.
To Boost Economic Growth: According to the Federal Reserve, the US economy is growing at a good rate. The Fed is further reducing interest rates to maintain and stimulate economic growth. Reducing interest rates makes it cheaper for businesses and consumers to borrow money that increases overall investment and spending which increases the GDP and economic growth.
To Reduce the Unemployment Rate: The US Job market is performing well but the unemployment level has increased slightly so the Fed is trying to increase jobs in the market and is seeking to achieve maximum employment, as reduced interest rates allow businesses to expand and hire more employees.
Cooling inflation rate: The Inflation rate in the US has seen a good downtrend from its peak of 9.1 % in June 2022 which shows the previous effort of the Fed has given great results. Currently inflation in Nov stood at 2.7% which is still somewhat elevated from the target of a 2% inflation rate but as the inflation rate is getting lower the Fed can afford to lower interest rates to achieve economic growth and maximum employment without risking a high inflation. (Reducing interest rates increases inflation because people borrow more money thus increasing demand and ultimately inflation).
Previous 3-year Inflation rate data of the US
Impacts on Financial Markets
Downfall in Sensex & Nifty
On the Next day of the announcement (Thursday) Sensex and Nifty fell by -964(1.2%) points and -247(1.02%) points respectively. Then the market continued the same downtrend from Thursday.
Why?
Better Earning opportunities: As the US economy is growing at a solid rate making the US dollar stonger, along with attractive US bond yields at around 4.52%, has diverted funds away from emerging markets like India. Foreign institutional investors have net sold Rs 12,230 crore worth of Indian equities over the four trading sessions(days) .
Hawkish stance of the Fed: It signaled only 2 rate cuts in 2025 which disappointed the global markets as people were expecting more cuts. Fed chair Jerome Powell also emphasized the risks of persistent inflation which means the Fed could increase interest rates in 2025 to control inflation, if the high inflation situation arises. This means the interest rate would remain high for a prolonged period of time thus investors prefer U.S assets because high interest rates offer safer and attractive returns.
Downfall in stock indexes
On Wednesday, financial markets experienced significant volatility as the Federal Reserve scaled back expectations for interest rate cuts next year, citing the robust performance of the U.S. economy. This adjustment led to a significant decline in stock indices as investors reacted to the Fed's cautious stance.
Key impacts of fed cut were:
S&P 500 plummeted by 3%, marking its most substantial drop since early August.
Russell 2000 fell by 4.4%, its steepest one-day decline in two and a half years, highlighting the vulnerability of smaller domestic companies.
Dow Jones Industrial Average declined for the tenth consecutive day, its longest losing streak since October 1974, closing down by 1,123 points or 2.6%.
Nasdaq Composite dropped by 3.6%, reflecting widespread sell-offs in the technology sector. The ripple effects of the Fed's policy adjustment were felt across various sectors, underscoring the market's sensitivity to interest rate expectations.
Impact on Indian Economy due to fed cuts:
The Indian Rupee hit an all-time low of 85.00 against the US Dollar, reflecting the pressure on emerging market currencies.
As investors moved funds to US bonds, the yields on Indian government bonds rose, increasing borrowing costs for the government and private sector.
Import costs got higher due to a strong dollar which led to inflationary pressures, resulting in higher prices for essential goods and services.
Also the Reserve Bank of India (RBI) faced pressure to adjust its own interest rates in response to the Fed’s actions, affecting domestic borrowing costs and economic growth.
Conclusion
In summary, the Federal Reserve’s third consecutive interest rate cut in 2024 caused significant market volatility. Major US stock indices, including the S&P 500, Russell 2000, Dow Jones, and Nasdaq Composite, faced substantial declines. In India, the rate cut led to capital outflows, rising bond yields, inflationary pressures, and potential interest rate adjustments by the Reserve Bank of India. The Fed’s cautious stance, aimed at balancing economic growth and inflation control, signals limited future rate cuts and prolonged high interest rates. This interconnected global financial impact underscores the complexity and challenges faced by investors and policymakers alike.
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