US Fed rate cut: What caught investors off guard

The Bombay Stock Exchange (BSE) Sensex plunged nearly 1,200 points, while the NSE Nifty 50 fell sharply to the 23,870-level following the US Fed's decision to implement a widely anticipated 25-basis-point rate cut. However, its forecast of only two additional quarter-percentage-point reductions in 2025 - half a percentage point less than expected - caught investors off guard.

This shift raised concerns about tighter global financial conditions, prompting risk-averse foreign investors to offload Indian equities. Consequently, both the Nifty 50 and Sensex have lost over 3 per cent this week alone.

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The Sensex opened at 79,029.03 points, significantly lower than its previous close of 80,182.20, and extended its losses to drop 1,162 points, settling at 79,020.08. Similarly, the Nifty 50 began the day at 23,877.15, down from its last close of 24,198.85, and further declined by 329 points to 23,870.30. The sharp sell-off reflects increasing caution among investors, driven by concerns over tighter global liquidity conditions following the US Federal Reserve's recent policy signals.

The impact of the market rout was stark, with the overall market capitalisation of BSE-listed firms falling to ₹446.5 lakh crore from ₹452.6 lakh crore in the previous session, wiping out ₹6 lakh crore in mere minutes of Thursday's (December 19) trade. Over the past four trading days, investors have faced losses of nearly ₹13 lakh crore, with market capitalisation declining from ₹459.4 lakh crore on Friday (December 13). The continued erosion underscores the market's vulnerability to global economic uncertainties and shifting investor sentiment.

Implications of Fed's decision for India

The Fed’s move, while aimed at sustaining the US economy, has significant ramifications for India. Historically, interest rate cuts in the US have bolstered emerging markets like India by encouraging foreign capital inflows. However, the latest projections have introduced uncertainty about the trajectory of global liquidity.

The Fed’s cautious approach has led to heightened volatility in Indian markets. Reduced prospects for aggressive rate cuts in 2025 could slow the pace of foreign institutional investments (FIIs) into Indian equities. Yet, analysts believe that sectors such as IT and infrastructure may still benefit from incremental foreign inflows, as India remains a high-growth destination.

Currency and inflation dynamics

The Fed's decision also influences the Indian rupee. Typically, a rate cut in the US weakens the dollar, supporting emerging market currencies. A stronger rupee would reduce the cost of imports, particularly oil, and help control inflation. However, if foreign inflows remain tepid due to the Fed’s tempered easing, the rupee may struggle to gain significant ground.

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The Reserve Bank of India (RBI) now faces a delicate balancing act. While the Fed's actions could alleviate pressure on the RBI to maintain high rates, persistent inflation and volatile capital flows may necessitate a cautious approach. The central bank might delay domestic rate cuts until global liquidity trends and inflation dynamics stabilise.

Fed Chair Jerome Powell underscored the resilience of the US economy, highlighting steady unemployment rates and moderated, though still-elevated, inflation. This robust outlook complicates the global investment landscape, as higher yields in the US could attract capital away from emerging markets like India.

Fed’s decision also presents opportunities

While the Fed's decision introduces short-term headwinds, it also presents opportunities. The anticipated moderation in US rates over the longer term could revive interest in Indian assets, provided the domestic economy remains stable and attractive to investors. Additionally, sectors tied to global growth, such as IT and manufacturing, stand to gain if global liquidity improves.

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The Indian stock market’s downturn reflects immediate concerns over the Fed’s revised outlook, but the long-term impact will hinge on how global economic conditions evolve.