Federal Reserve’s rate cut is already discounted

Federal Reserve’s rate cut is already discounted

In a volatile week, equities traded higher covering most of August’s losses on bargain buying, tracking surging GDP (gross domestic product) and falling inflation. The Sensex, the benchmark index of the Bombay Stock Exchange (BSE), rose 10.1% in the last 11 sessions and, at the last close, was only 1.79% away from its all-time high, which it touched on 24 July.

The gains on local bourses were also influenced by a rally on global bourses, where Hong Kong covered its entire loss and the US also witnessed good gains in the initial part of the week. However, disappointment over economic data pulled down the Dow and Nasdaq in the later part of the week.

On Wednesday, data on housing led to the Dow falling 145 points. And on Friday, after data showed the first monthly drop in payrolls in four years and fanned fears of an economic recession, the Dow fell by another 250 points.

The “hopefuls" see a positive side in this as it makes a perfect case for the US Federal Reserve (Fed) to announce a big rate cut in its meeting on 18 September. However, the event of interest rate cut is fully discounted; the only argument relates to the magnitude of the cut.

There is confusion on how the markets will react when they open on Monday, amid hopes of a larger rate cut by the Fed than initially expected.

Heading south

My analysis suggests that this time, the markets will fall. Talk of a cut in interest rates is now not new and a rate cut of 25 basis points has already been discounted. The quantum of the rate cut would depend on further data from the US such as like initial jobless claims, consumer confidence, retail sales and industrial production, all scheduled for release this week.

If the economy fares well on these counts, then the possibility of the Fed adopting a cautious approach to interest rates may arise. Importantly, since most of these numbers are expected in the later half of the week, the debate over the quantum of the rate cut may not be an effective shock absorber for global markets.

Other factors, including the hardening of the yen against the dollar on Friday, will also get reflected in early trades on Monday.

The dollar fell to its 15-year low against the world’s major currencies on Friday. And it is widely expected that the rate cut could further weaken the dollar. A lot has happened in the financial world on Friday and the markets are just hoping that the worst thing that can happen—recession in America—does not actually happen. Keeping these factors in mind, I think that markets may resume lower and fall further.

Local cues

Back home, too, get set for a weak start on Monday. Watch the rupee for further cues as it is likely to strengthen further on Monday and make technology stocks weaker. Strong global crude prices are a big concern as latest reports suggest that domestic petrol and diesel prices are set to rise, creating inflationary pressures again and reducing chances of a cut in domestic interest rates in October.

However, the credentials of Indian economy are as strong as ever. Moreover, an interest rate cut in the US would mean more inflows to emerging markets, and India is a favoured destination for foreign investors. There is not much cause for concern as far as long-term prospects are concerned.

Technically speaking

Technically, the rising Sensex is likely to see its first resistance at 15,712 points, and then at 15,869. If the Sensex breaches this level, then 16,000 points will become a reality.

On the downside, the Sensex will see its first support at 15,566 points. Any close below this would mean a further fall, down to 15,350. The next support comes at 15,142 and 14,975 points.

The stocks that may offer attractive opportunities during the week include Bharti Airtel Ltd and Tata Power Ltd. Bharti Airtel, at its last close of Rs847, has limited downward potential and once the market settles, the stock may move up to Rs876 with a stop-loss of 792. Tata Power at current market price of Rs718 is in consolidation phase and can move up to Rs742, with a stop-loss of 684.

From last week’s recommendations, HDFC Bank Ltd met its target of Rs1,212 on Monday, while Housing Development Finance Corp. surpassed its target of Rs2,050 by hitting a high of Rs2,150, thereby gaining 9.14% during the week.

ABB Ltd, too, was a cracker of sorts as the stock touched a high of Rs1,217 against the target of 1,186.

Vipul Verma is a Delhi-based investment adviser. Your comments, questions and reactions to this column are welcome at ticker@livemint.com