Short analysis on the US Fed rate cut

-     The US Fed FOMC, yesterday, announced its federal fund (policy) rate wherein the committee decided to reduce the federal fund rate by 25 bps which is the “third rate cut” in 2019. Federal fund rate now stands in the range of 1.5% to 1.75%. The rate cut decision was based on 8-2 votes in favor of the rate cut.          

-          Rationale for the decision:

o   Labor market remains strong and the economic activity has been rising at a moderate pace (GDP for Q3-2019 came in at 1.9%)

o   Job gains have been solid while unemployment rate has been low

o   Household spending has been driving the overall GDP growth while on the other hand business fixed investments and exports remain weak.

o   Both CPI and core CPI remained below 2%; Longer term inflation expectations are little changed

-          Future outlook on US interest rates:

o   Further rate cut actions will be assessed based on incoming information for the economic outlook, keeping the objective of maximum employment and 2% inflation target in mind.

-          How have interest rate changes been over the past few years

                                               US Federal Fund rates (Mid-point plotted)

o   During 2018, the US Fed raised rates by almost 1% as retail inflation remained at around 2.5% for majority of 2018. US unemployment during 2018 remained between 3.5-4.

o   In 2019, the US Fed has declined rates by 75 bps supported by domestic growth concerns. US GDP growth has declined from 3.1% in Q1-2019 to 1.9% in Q3-2019.

§  It is also important to note that US retail inflation during this period has remained below or equal to 2% during 2019 which has extended confidence in the members of FOMC to cut rates in order to support the growth concerns.

-          How do US GDP numbers depict the strength in the US economy?

o   The US Fed FOMC has pointed out that the strength in the US economy gas been driven by personal consumption expenditure while the weakness in gross private investment and exports remains. This can be validated in the following table.

	Q2-2018	Q3-2018	Q1-2019	Q2-2019	Q3-2019
GDP	3.5	2.9	3.1	2.0	1.9
Personal Cons Exp	4.0	3.5	1.1	4.6	2.9
Gross private domestic investment	-1.8	13.7	6.2	-6.3	-1.5
Exports	5.8	-6.2	4.1	-5.7	0.7
Imports	0.3	8.6	-1.5	0	1.2
Govt CE and investment	2.6	2.1	2.9	4.8	2.0

-          Common Thread between US and India Monetary Policy:

	2018	2019
RBI	Increase in rates by 50 bps	Decrease in rates by 135 bps
US Fed	Increase in rates by 100 bps	Decrease in rates by 75 bps

o   The RBI had increase policy rates by 50 bps in 2018 highlighting inflation concerns. On the other hand US Fed increased policy rates by 1% in 2018 highlighting the same reasons.

o   The RBI has been slashing policy rates since February 2018 aggregating 135 bps citing benign inflation and pressing on the importance of reinvigorating aggregate demand.

o   However, there is a slight difference in the commentary between the two central banks. US Fed has stated that the economy is growing at a moderate pace and hence further rate cuts will be data driven. While in case of India, the pick-up in overall growth remains a concern and the MPC will continue with an accommodative stance as long as it is necessary to revive growth.

  

-          Impact on markets:

o   The US equity markets have reacted positively. Dow (0.43%), S&P 500 (0.33%) and NASDAQ (0.33%) ended in the green yesterday. But not to forget the gains were also supported by better than expected corporate earnings.

o   As a natural reaction, US dollar weakened against major currencies owing to lower demand for the US dollar. Also the US yields declined yesterday by 7 bps. However, the fall could have been limited as the Fed commentary states that future course of action would be data driven, indicating that the future course of rate cut action is not given.

o   The gains in the local US equity markets since the partial trade agreement between US and China had led to rise in US yields. The markets were expecting  a rate cut action by the US Fed but despite that the yields have risen from 1.74% (on 16^th October) to 1.84% (on 29 October).

o   How have Indian markets reacted?

§  The markets have risen by around 3.8% since 16^th October. Yesterday the Sensex rose by 0.55%. Sensex continues to remain above 40,000 at present, rising by more than 250 points (till 11:30 am)

§  This has been primarily on account of higher FPI inflows. Higher FPI inflows have aided in strengthening of the Rupee against the US dollar.

§  10 year benchmark GSec yields too declined on Wednesday to 6.49%.