The US Fed Rate Change Sojourn and Inflationary Context, US Fed, US Equity Markets, Indian Markets, Fed, Nasdaq, Dow Jones, S&P 500, Nifty, Banknifty, Markets, US inflation, Rate cut, 2025 Rate cut

The US Federal Reserve decided to cut its key benchmark interest rates by 0.25% on December 18, 2024, triggering significant reactions across the financial markets. This reduction brings down the key rates range from 4.5-4.75% to 4.25-4.5%. This decision marks the third of its kind in the consecutive cuts witnessed in 2024. The US Fed has also indicated a slower pace of reductions in 2025—projections of only two cuts. This move reflects the US Fed’s intent to cool off inflation and also aims to foster economic growth.

US Fed’s Rate Change Sojourn and Inflationary Context:

The Fed’s decision to lower interest rates is the continuation of the rate-cut sojourn that began in September 2024.

Let us explore the timeline of rate changes along with the inflationary context:

  • March 2022:

The Fed started its rate hike cycle, raising the rates from 0% to 0.25-0.5% in response to increasing inflation. The inflation was close to 6.9% then due to several factors – Supply chain disruptions, Aggressive stimulus measures during the Covid-19, and Rising Energy Prices owing to a certain geopolitical crisis.  

  • May 2022:

The Fed increased the rates by 0.5% bringing the target range to 0.75-1%. Inflation increased to 8.2% prompting further action to cool down the economy.

  • June 2022:

The Fed increased significantly by 0.75%, raising the range to 1.5-1.75% as inflation surged to 9.1%. 

  • July 2022:

Inflation was at 9.2% and, the Fed increased the rates by another 0.75%, raising the range further to 2.25-2.5%.

  • September 2022:

Interest rates were raised by another 0.75%, resulting in a range of 3-3.25%.

  • November 2022:

The rates were increased by another 0.75%, with inflation still showing little signs of cooling off. The rate range went up to 3.75-4.00%.

  • December 2022:

At this point in time, inflation displayed some signs of stability and, hence the rate hike was less at 0.25%. The range reached 4.25-4.5%.

  • February 2023:

The Fed raised interest rates by another 0.25% increasing the range to 4.5-4.75%. Inflation still hovered above the target levels.

  • March 2023:

Rates were increased by another 0.25%, resulting in the range of 4.75-5.00%.

  • May 2023:

Rates were increased by another 0.25%, pushing the rates to the 5.00-5.25% range.

  • July 2023:

The peak rate was reached with an increase of another 0.25%, resulting in a range of 5.25-5.5%.

  • September 2024:

The Fed cut rates for the first time since March 2020. The rates were cut by a whopping 0.5%, bringing the range down to 4.75-5.00%. The rates were cut owing to the reduction in the inflationary pressures.

  • November 2024:

The Fed further cut the rates by 0.25%, to a range of 4.5-4.75%.

  • December 2024:

The Fed on December 18, 2024, announced a further reduction of 0.25%, bringing down the rates range to 4.25-4.5%.

When inflation rose in early 2022, the Fed responded aggressively by hiking rates, which aimed to cool down inflation. The series of rate hikes from near zero to over 5.25%, was primarily aimed at combating inflationary pressure by targeting a reduction in consumer and business spending. As inflation cooled off and showed signs of moderation, and inflation cooled off to a level of 2%, the Fed started implementing rate cuts.

US Consumer Price Inflation Rate

(Source: https://www.forexfactory.com/)

Rate Forecasts for 2025:

However, the Fed’s updated projections during the December 18 FOMC(Federal Open Market Committee) meeting, was a significant shift from its earlier policy stance. Investors were expecting a more aggressive rate-cutting trajectory in 2025, and there was an expectation of four rate cuts in 2025. However, the Fed revised its rate cut stance to two cuts. The central bank’s stance underscores a conservative outlook, as inflation still appears to be a major challenge along with a resilient labor market.

Impact on US Equity Markets:

The immediate impact of this announcement resulted in a broader sell-off in the US equity markets. The major indices witnessed a significant decline.

  • The Dow fell to ~1200 points by approximately 3%. This decline marked its longest losing streak from December 5, 2024. The Dow has corrected close to ~2800 points.
  • The S&P 500 dropped by ~180 points, closing at 5872 on closing hours of December 18, 2024.
  • The Nasdaq composite fell by ~720 points, closing at 19,393 levels. This correction was probably one of the largest declines in a single day during the recent months.

The decline was evident in the interest rate-sensitive sectors. Real estate stocks saw a significant decline as the cost of borrowing pressure, will continue to pose a challenge. The decline was also witnessed in consumer discretionary stocks, notably in the Tesla and Amazon stocks. Tesla fell by 8.3% and Amazon corrected 4.6%. These declines reflect the dampening mood of the investors as a seemingly prolonged interest rate range might reduce consumer and business spending, stifling growth.

Impact on Indian Markets:

The ripple effects of the Fed’s decision were also felt in the Indian markets. Today’s(December 19, 2024) market opened at a significant gap down. The Nifty opened at 23,877.15, while the Banknifty opened at 51,428 levels. Historically, US rate cuts have been favorable for emerging markets, as they tend to boost foreign inflows seeking higher returns. However, a hawkish signal from the Fed has triggered a certain level of volatility in the market. India is also facing an additional challenge of currency depreciation which often leads to capital outflows. Concerns also loom large over the deteriorating earnings of Indian markets. Q1 and Q2 posited a weak earning season and, the broader sentiment is that Q3 will follow suit. The recovery in the earnings is only expected by Q4 (source: Motilal Oswal Mutual Fund News).

The Federal Reserve’s recent rate cut, coupled with its change in the policy stance for 2025, has introduced a new dynamic in both U.S. and Indian financial markets. While the immediate market reactions have been negative, the long-term implications will depend on how economic indicators evolve and how policymakers in both countries respond to these developments.

(Source:Federal Reserve)