Sensex, Nifty: Will stock market rally post US Fed rate cut decision today?

Benchmark indices Sensex and Nifty were range-bound in Wednesday's trade, much in line with Asian peers, as investors globally eye the outcome of the two-day US Federal Reserve's policy review later today. Analysts are largely betting on a 25 basis points (bps) rate cut, though they do not rule out a bigger 50-bp move. What stock investors would cheer, analysts said, is a small cut with a dovish Fed commentary on future rate cuts.   

"We expect the FOMC to cut rate by 25 bps at its September 18 meeting. The dot plot will likely indicate a base case of gradual easing," Nomura said.  

European Central Bank (ECB) recently cut its deposit rate by 25 bps, lowered its growth and raised its core inflation forecasts. Nomura expects the Bank of Japan (BoJ) policy rate would be left unchanged in this week's policy review.

"The significance of the Fed rate decision tonight is evident from the wait-and-watch market mood across the globe. Perhaps more important than the Fed action would be its commentary and the message. An ideal and possible outcome would be a 25 bps rate cut with a dovish message, indicating a series of rate cuts. Good retail sales data along with a weakening US labor market point to such a possibility,"  said VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

This would mark the first rate cut in four years. Fed Chair Jerome Powell recently showed confidence in cutting rates, citing inflation levels close to the central bank’s 2 per cent target.

Historically, the US Fed announced a 50 bps rate cut 10 times in the last three decades, which resulted in a median return of 1.6 per cent for the Nifty. A 25 bps cut has been followed by a modest 0.5 per cent decline, Capitalmind Financial Services noted.  Out of the 78 US Fed rate decisions in the last 34 years, Nifty delivered positive closings on 50 occasions on the following trading day of the announcement.

"Our expectations is that of a 50 basis cut - with US  elections coming up and based on other empirical evidence the possibility of a half percentage rate cut is more likely to address the perception that Fed is perhaps behind the curve," said Arindam Ghosh Co-Founder of Alphaniti Investment Advisors. The messaging from Jerome Powell on how far and how fast his central bank will move will give idea on how the Fed is looking at data and the economy and global markets will take cue from that, Ghosh said. 

A couple of brokerages compared the past three Fed rate cycles, but offered mixed views on whether the fresh cycle could result in a market rally from here on. 

"Theory suggests a valuation boost; history augurs otherwise. In 2001, Nifty fell 35 per cent; in 2007, it melted up initially, but plunged 60 per cent in 2008; in 2019, it stayed flat. State of US labour market/recession risks, domestic demand and valuations explain the varied outcomes. Today, many US labour market indicators are flashing red; unlike 2007, domestic demand is soft; and unlike 2019, valuations are stretched. This warrants caution," Nuvama said in a recent note.  

On Wednesday, the BSE Sensex was up 156.27 points or 0.19 per cent at 83,235.93. Nifty stood at 25,465.95, up 47.40 points or 0.19 per cent. 

IIFL Securities argues that one cannot compare the last three rate cut cycles. It said while the first two rate cuts of 2001 and 2007-08 were influenced by unique economic events: the dot-com bubble burst and 9/11 attacks in 2001; and the housing market collapse and global financial crisis (GFC) in 2007-08; the 2019-20 rate cut cycle was due to pro-active cuts aimed at supporting growth, ahead of weakening of the economy. The phase II of 2019-20 cuts was in response to Covid.  

IIFL Securities said today’s situation resembles only the first phase or August 2019-February 2020 pre-Covid rate cut cycle. 

"We see that equities rose in the period up to and during rate cuts, yields fell, commodities softened (surprisingly), gold rallied and FII were net buyers. Our base case of Nifty EPS growth at 10-11 per cent has upside risks from softening commodities and should be supportive of market levels," it said.

Domestic and global indices responded positively to rate cuts during the 2019-20 period. In the six months leading up to the cuts, S&P 500 and Nifty rose 12 per cent and 5 per cent, respectively. 

Even during rate cuts, S&P 500 and Nifty advanced 15 per cent and 10 per cent, respectively. Sectoral performance varied, with IT, Utilities, Healthcare, & Media outperforming in the US, while Consumer discretionary, real estate, financials, and auto sectors outperformed in India, IIFL Securities noted.