US Fed policy preview: Status quo on rate likely. Here's what stock market would focus on

The two-day US Federal Reserve policy review will conclude on Wednesday. It is almost a consensus view that the US central bank would keep interest rate unchanged today, with prospects of a hike in rate by 25 basis points in November meeting falling to 31.5 per cent, as per CME Fedwatch tool. Analysts said the policy outcome, the Fed Chair Jerome Powell's commentary and the new dot plot projections would be keenly followed. Also, eyes would be on FOMC updates on long-term economic growth projections, which include forecasts for GDP growth, unemployment rates, interest rates and inflation.

"Today, the Federal Reserve is expected to keep rates unchanged and will continue to roll-off its $8.1 trillion balance sheet. The central bank will continue to allow up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities (MBS) to mature and roll off its balance sheet per month," said Motilal Oswal Securities. 

The domestic brokerage said that the impact of Fed tightening is still having a negative effect on the economy and caution is warranted as growth is slowing.

"Investors are betting that the Fed could be nearing its rate-hiking cycle, assigning just a 30 pr cent chance to a November increase. If the chair does anything to disabuse the market of that sentiment, it would be meaningful. Fed officials are likely to signal one more quarter point interest rate increase when the central bank will publish its so-called ‘Dot-Plot” of individual projections," it said. 

Nomura India said the Fed is widely expected to hold policy rates, but market focus will likely be on the new dot plot projections and Chair Powell’s press conference.

"Our US economics team expects the dot plots to show three rate cuts instead of four earlier (median 2024 dots at 4.875 per cent vs 4.625 per cent in June vs current Fed futures pricing of 4.875 per cent). We do not necessarily think this would be a hawkish outcome beyond any initial knee-jerk moves," Nomura said this week.

Ahead of the Fed outcome, the BSE benchmark Sensex tanked 796 points, or 1.18 per cent, to close at 66,800.84. The NSE benchmark Nifty barely managed to hold above 19,900 level and was down 231.90 points or 1.15 per cent for the day. Fear gauge India VIX rose 2.69 per cent to 11.13.

The latest monthly BofA Securities Fund manager survey indicated that six out of 10 fund managers in August felt the Fed is done with interest rates. This is against 9 out of 10 who felt the Fed was not done. A total of 74 per cent of the participants expected the first rate cut by the Fed by second quarter of 2024 or in the second half of the calendar 2024.

Data showed US Consumer Price Inflation (CPI) for August came in at 3.7 per cent, which was 10 basis points higher than consensus estimate. This was the second month in a row where inflation moved up. On the other hand, jobs data suggested unemployment rate ticked up in August, while adding 1,87,000 jobs in August, suggesting the economy remains resilient. The Fed minutes of recent policy review suggested that rate decisions would be data-dependent.

HSBC this month said: "US inflation has fallen quickly, and although it is not yet at the 2 per cent target, the Fed has probably already completed its rate hikes," it said. Out of 14 rate hike cycles in the US since 1950, 11 ended in recession, CLSA suggested in a note.

In the case of dollar index, it has been on a rise since sub-100 levels in June. The index, which usually has inverse relationship with emerging market equities (EMs), is holding above the 105 level. The Fed commentary may influence the index movement and also flows into EMs like India. 

Data suggests FPIs are net sellers of domestic equities to the tune of Rs 5,213 crore in September so far.

Nuvama Institutional Equities in a August 28 said the Fed has confronted the inflation scourge before—1940s and 1970s—but it had the cushion of dollar’s gold-like status in 1940s and of low sovereign debt in 1970s.

"Today, there are no such cushions. Any premature rate reversal could risk dollar fall/inflation spike. But tighter for longer could further gnaw at the sovereign debt dynamic. Hence, risks from the Fed tightening this time round may be creeping in from the back door (sovereign balance sheet), not so much from the front door (HH balance sheets)," it said.

The brokerage noted that the Fed’s challenges are exceeding its capacity for the first time.

"It has no good choices; only bad and worse. Recession is surely delayed, but is still the path of least resistance. It may be a bad outcome, but not having one now could potentially be worse. A likely US recession would cast its shadow on India’s business/profit cycle. Profits are a function of both domestic leverage (HH and government) and external leverage (global demand)," it said.

History, the brokerage said,  shows that the credit cycle stalls either due to a liquidity shock (BoP crisis: 2011–14) or demand erosion (NGDP slowdown: 2018–19). It may well be the latter this time.

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