Active Stocks
Sat May 18 2024 12:29:54
  1. Tata Motors share price
  2. 953.75 0.85%
  1. Power Grid Corporation Of India share price
  2. 316.10 0.88%
  1. ITC share price
  2. 436.50 -0.02%
  1. Tata Steel share price
  2. 167.90 0.39%
  1. State Bank Of India share price
  2. 820.35 0.31%
Business News/ Money / Personal Finance/  What you should know about rate cuts this year

What you should know about rate cuts this year

Rate cuts in India are likely to happen sometime in the second half of calendar 2024.

Dynamic investors take positions prior to expected market moves.Premium
Dynamic investors take positions prior to expected market moves.

The market is positioning itself for the potential interest rate easing cycle in 2024. Yes, it is very likely. Here are a few aspects to give you a perspective on the rate cut scenario.

Why is it expected? Foremost, inflation is expected to ease. CPI inflation is expected to average 5.4% in 2023-24. It is expected to average 5.2% in April-June, 4% in July-September and 4.7% in October-December, as per projections put forth by the Reserve Bank of India (RBI). These projections are a shade higher than the central bank’s target of 4%. Second, India’s GDP (gross domestic product) growth is buoyant, but it will do well to get a little support from interest rates. Finally, globally, interest rate easing cycle is expected to start soon, between March and Mayin the two large economic blocks, USA and Eurozone. China is anyway easing interest rates already.

When is it expected to start? In India, this is expected to happen sometime in the second half of calendar 2024. The US Federal Reserve has communicated through the ‘dot plot’ (the opinion of the members of Federal Open Market Committee on Fed rate) that policy rate will be eased, starting 2024. The European Central Bank has gone soft on it economic outlook. However, for RBI, the stance still remains ‘withdrawal of accommodation’. There is no definition of this term; it is a stance somewhere between neutral and hawkish. Prior to RBI easing interest rates, it will have to change this stance to neutral.

RBI will do so when there is evidence that CPI inflation is trending towards the target 4%. The six-member Monetary Policy Committee (MPC) will have to agree to a rate cut, by majority vote. That may happen sometime in the first half of calendar 2024, paving the way for rate cuts in second half of 2024.

How much is it expected to be? It is expected to be a shallow rate cut cycle. The MPC members have a perspective on real positive interest rate, calculated on CPI inflation and repo rate. There is no communication on how much they want the real interest rate to be. Currently, the repo rate is 6.5%. If CPI inflation is, for instance, 5%, then the real positive rate is 1.5%. MPC would like to have a buffer as well, in case inflation flares up due to unforeseen circumstances. Hence the next policy rate easing cycle is expected to be in the range of 50-75 basis points (bps), i.e. 0.50= 0.75%. The repo would then be 5.75% or 6%, and CPI inflation should be adequately lower.

How much would yield levels react? Calling the market is fraught with risks and on momentum, it can go anywhere in the short run. As a long-term trend, the average spread, i.e. differential between RBI repo rate and 10-year benchmark government bond yield over the last 23 years, is approximately 1%. Currently, the 10-year yield is hovering around 7.2% and the repo rate is 6.5%. The spread, at approximately 70 bps (0.7%) is lower than long-term average. If the rate cut is say 50 bps, the 10-year yield would settle somewhere around 7%. If repo rate is eased to say, 5.75%, it would settle somewhere around 6.75%. The 10-year government bond is only one of many in the market. It is referred to in the absence of a widely-followed index for bond yields.

When is the market likely to move? The bond market typically reacts prior to the policy rate easing cycle, when expectations are being built in, and in the initial half of the easing cycle. Towards the end of the policy cycle, the market starts positioning for the end of the cycle. Hence, sometime next year, when there are stronger indications, for example inflation moving as per projections or RBI changing its stance, we should see a palpable move in yields.

Re-investment issue: As and when the potential rally in yield levels happen, all yield curves are expected to move down. That is, various maturities of government bonds, and corporate bonds, are expected to ease. If you book profits after the rally and re-invest in debt, then yield levels would be relatively lower.

Dynamic investors take positions prior to expected market moves. However, it is better to be aware of the relevant aspects.

Joydeep Sen is a corporate trainer (financial markets) and author

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed - it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 07 Jan 2024, 08:44 PM IST
Next Story footLogo
Recommended For You