Stock market & Fed rate cuts: How Nifty fared in last 3 cycles; what's ahead?

The US Federal Reserve (Fed) looks all set to cut the Fed rate by at least 25 basis points in its September 17-18 policy review next week. This, if it does, would kick start the fourth full-fledged rate cut cycle in the US in 25 years. The Fed rate cuts have historically been positive for domestic stocks. Will this time be different?

The Fed officials have given the impression that their base case is for 25 basis points rate cut, but maintained optionality for more aggressive easing. In the last 25 years, the Fed has engaged in three full-fledged rate cut cycles, the first in in 2001, the second in 2007-08 and the third in 2019-20.

While the first two 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.

The brokerage noted that commodity prices weakened during the 2019-20 rate cut cycle and that it expects commodities to remain soft, benefiting Indian companies going ahead.

On Wednesday, crude oil prices fell below $70 a barrel mark. IIFL Secuirties said OPEC is under pressure and crude can fall further. On the other hand, bond yields declined during 2019-20 rate cuts and can decline further from current levels. Gold rallied prior to and during rate cuts on account of its safe haven status, it noted.

"Our base case is - Nifty EPS FY24-26 growth will be 10 per cent with upside growth, global rate cuts are spread over the next 15 months and Nifty can deliver high single digit returns. We expect RBI to start easing from Q3FY25 and a rate cut may happen simultaneously with change in stance. Capex could see a spurt in 2HFY26 basis widening of differential between NGDP growth and Borrowing costs," IIFL Securities said.