By Priti Goel

The US economy is the largest and most developed in the world, accounting for about 20% of global output, mainly driven by the services sector (which contributes about 80% of its GDP). As of the second quarter of 2024, the U.S. Gross Domestic Product (GDP) is approximately $28.63 trillion.

Followed by China with a GDP of $19.37 trillion, Japan with $4.94 trillion, Germany with $4.22 trillion, and India of $3.3 trillion. The U.S. GDP per capita is approx. $73,600, ranks high globally, reflecting its strong economic output and relatively higher standard of living (except Luxembourg and Singapore which have higher GDP per capita, due to smaller population and focused economies). The U.S. market capitalization is approx. $50.8 trillion.

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At the latest U.S. Federal Reserve meeting on July 30-31, the central bank held its federal funds rate steady at a high of 5.25-5.50%. The Consumer Price Index for all urban consumers, i.e. inflation rate was 3.0% in June’24 (next data on August 14). The personal consumption expenditures (PCE) price index, which the Fed targets at 2%, has risen over the past few months.

The Federal Reserve is considering a rate cut in September 2024 due to several key factors:

Inflation trends – Recent data shows that inflation is decreasing, with annual inflation rate dropping to 3%, the lowest in three years. This gives Fed the confidence that inflation is moving towards its 2% target.

Economic growth – The Fed aims to support economic growth, which has shown signs of slowing down. By cutting rates, the Fed hopes to stimulate economic activity.

Market expectations- Traders are highly confident that the Fed will cut rates, with a 100% probability of a rate cut by September. This expectation is based on recent economic data and statements from Fed officials
Global investor’s interest in the US market in a potential rate cut scenario can have several significant impacts.

1. Market Performance – can lead to positive performance in fixed income assets, particularly US Government Bonds. Equities can also perform well if rate cut helps avoid recession
2. Investor Sentiment – can boost investor confidence globally and can lead to increased investment in the US markets, driving up stock prices, leading to more bullish market environment
3. Capital Flows– US market will become more attractive, seeking higher returns compared to other markets. Can increase capital inflows into US equities and bonds.

If Fed successfully lands lowering of interest rate without triggering a recession, it could maintain positive market sentiment. On contrary, if rate cut fails to prevent a recession, it could lead to market volatility and reduced returns on equities.

So what should global investors in emerging markets do ahead of potential U.S rate cut?

1. Avoid making short term changes in the portfolio based on modest change in interest rate policies. Stay with your long-term, diversified portfolio
2. Should you still want to make adjustments, certain sectors are expected to perform better lower-rate environment

a. Decline in borrowing cost can positively impact growth stocks, as future earnings tend to increase with lower interest payments on loans taken. Technology and communication services are two sectors which can be leveraged / added in the portfolio

b. Real estate sector benefits from lower borrowing costs as REITs often rely on debt to finance acquisitions and develop projects. Lower borrowing cost can enhance profitability and boost cash flow which REITs can use towards reinvestment, etc.

c. Small cap stocks tend to do well in lower interest rate scenarios as they are more sensitive to interest rates than large cap firms as the small firms use more external financing for growth

d. Rate cuts will make Treasury bills, certificate of deposits and money market funds less attractive

e. Riskier assets like emerging markets and metals are likely to do well. Precious metals like gold and silver too should benefit from rate cuts

Indian markets are expected to mirror the positive sentiments on potential US rate cuts ahead. US 10- year bond yields slipped sharply lower (inversely correlated to bond prices) and was 3.97% (below 4% mark) on Friday, 9th August.

September rate cut could channel more investments into emerging markets (EMs) with India standing to benefit substantially. India’s robust economic position could attract increased investor interest, a high probability of nifty marching beyond 25,000 levels then; and Indian IT companies may see a rebound.

This environment not only benefits large cap industries but also enhances broader economic stability. Indian rupee was valued at 83.94 as of 9th August, the influx of foreign capital in event of US rate cuts could strengthen the currency and economic prospects.

(Author is Founder & CEO of Prisha Wealth Management Private Limited, a SEBI Registered Investment Adviser)

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