The Hindu Business Line : Fed rate cut already factored in

Stock markets across the globe are awaiting yet another interest rate cut by the Federal Reserve in a bid to aid the beleaguered credit markets and to keep the US economy from sliding into a recession.

The Federal Reserve Chairman, Mr Ben Bernanke, and the Vice-Chairman, Mr Donald Kohn, have almost assured the financial markets in speeches made last month, that a rate cut is on the way. The hopes of another rate cut to arrest the ‘turbulence’ in the financial markets made the Dow Jones Industrial Average reverse from a correction on November 26 and the index has gained 8 per cent since then.

Other global stock markets, including India have also participated in the rally that was induced by expectation of a rate cut by the Federal Reserve.

Euphoric

That is, most equity markets have already discounted a 25 basis points cut in the Federal fund rate. The stock markets are not likely to get euphoric and soar higher if Mr Bernanke delivers a quarter basis points cut.

However, according to Bloomberg, traders are estimating a 26 per cent chance of a half point reduction. Such largesse would make equities ecstatic. When the Federal Reserve cut the Federal Funds Rate and the discount rate by 50 basis points in their September 18 meeting, the DJIA closed with a 2.5 per cent while the Sensex closed with a 4 per cent gain.

Indian markets have not always emulated the US markets after the Federal Reserve’s rate changes when the change was a minimal 25 basis points. But when the rate change is greater than 25 basis points or if the accompanying statement is overtly bullish or bearish, Indian markets have moved in tandem with the US equities.

Higher growth

This was apparent in June 2006 when the Federal Reserve hiked rates by a quarter basis points but weak economic data pointed towards an end of the rate-hike cycle. The DJIA closed 2 per cent higher after this meeting while the Sensex rose by 4 per cent.

A rate cut, whether 25 or 50 basis points, would be beneficial to Indian stocks as it would induce funds to move out of US in to emerging markets in search of higher growth and returns.

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