Why in News?

The U.S. Federal Reserve's (or Fed, which is the central bank of US) remarks suggesting two rate cuts in 2025 instead of the four originally announced caused frontline stock market indices to fall more than 1%.

Additionally, the Indian rupee (INR) fell to its lowest point ever, 85.13 (spot) to the US dollar, due to a sell-off that was allegedly spearheaded by Foreign Portfolio Investors (FPIs).

What’s in Today’s Article?

• What is a Fed Rate Cut?
• Why Does the Fed Cut Rates?
• Impact of the Fed Rate Cut on Financial Markets
• Recent US Fed Rate Cut Decision and its Global Impacts
• Indian Market Response US Fed Rate Cuts
• Future Outlook for India

What is a Fed Rate Cut?

• A Fed rate cut refers to a reduction in the federal funds rate, the interest rate at which banks lend money to each other overnight.
• Set by the Federal Reserve's Federal Open Market Committee (FOMC), this rate serves as a benchmark for various interest rates in the economy.
• The Fed uses rate cuts cautiously to strike a balance between promoting growth and controlling inflation.

Why Does the Fed Cut Rates?

• The Federal Reserve adjusts the federal funds rate to achieve two main objectives:
  • Price stability: Managing inflation to keep it within an acceptable range.
  • Maximum employment: Stimulating economic growth and job creation.
• Key reasons for a rate cut include:
  • Boosting economic growth: When the economy weakens, lower rates encourage borrowing and spending.
  • Counteracting external shocks: Events like financial crises or global pandemics may prompt the Fed to lower rates.
• By lowering rates, the Fed aims to stimulate economic activity, making borrowing cheaper and increasing disposable income for individuals and businesses.

Impact of the Fed Rate Cut on Financial Markets:

• Stock market rally: Investors perceive rate cuts as positive, often leading to a rise in stock prices.
• Bond price increase: Existing bonds with higher interest payments become more valuable as new bond rates drop.
• Currency depreciation: A weaker US dollar can make American exports more competitive globally, potentially boosting economic growth.

Recent US Fed Rate Cut Decision and its Global Impacts:

• US Fed decision:
  • The US Federal Reserve reduced its benchmark interest rate by 25 basis points to a range of 4.25%-4.5%.
  • It signaled only two rate cuts for 2025, down from the previously projected four, unsettling global markets.
  • Federal Reserve Chairman Jerome Powell emphasised a cautious approach due to concerns over inflation.
• Global market reaction:
  • US stock indices suffered significant losses: Dow Jones fell 2.5%, its longest losing streak since 1974. S&P 500 and Nasdaq Composite plunged 3% and 3.5%, respectively.
  • Asian markets mirrored the downturn: Japan’s Nikkei 225 and Hong Kong’s Hang Seng dropped over 1%.

Indian Market Response US Fed Rate Cuts:

• Stock market decline:
  • BSE Sensex fell by 964.15 points (1.2%) to 79,218.05.
  • Nifty closed at 23,951.7, down by 247.15 points (1.02%).
  • Sectors sensitive to interest rates, such as banking and real estate, faced sharp declines.
• Rupee at record low:
  • The Indian Rupee closed at an all-time low of 85.07 against the US Dollar.
  • Persistent FPI outflows (reached Rs 4,224.94 crore on Thursday), strong US Dollar, and global equity sell-offs pressured the currency.
• Shift to defensive investments:
  • Defensive sectors like pharmaceuticals outperformed as investors sought safer options amid volatility.
  • Midcap and small-cap indices also declined but showed partial recovery by the session’s end.

Future Outlook for India:

• RBI’s monetary policy influence:
  • The Reserve Bank of India (RBI) may postpone significant rate cuts to navigate global uncertainties.
  • Intervention by the RBI or lower crude oil prices could offer temporary support to the rupee.
• Investor outlook:
  • Ongoing caution among FIIs and reliance on defensive strategies reflect persistent market uncertainties.
  • Crude oil prices and central bank interventions remain critical factors for currency and equity market stabilisation.