Where are interest rates headed?

Apart from and corporate earnings, another crucial macro fundamental that impacts stock markets is the interest rate.

As Warren Buffet famously said, “interest rates are to asset prices like gravity is to apples.” Softening are fodder for the bulls. Peaking of interest rate, and expectations that it will trend down, have played a major role in the ongoing global bull market.

But the complexity of the global economic scenario, and the uncertainty surrounding trends in the mother market US, have clouded the interest rate trajectory.

will be much lower than expected

This year began with market expectations of six rate cuts by the in 2024. The Fed’s ‘dot plot’ indicated three rate cuts.

The near consensus in the market was that the slowing and the weakening labour market will give enough headroom for the Fed to cut rates.

Hard landing of the was completely ruled out by the market and soft landing became the base case scenario. But the US economy continues to surprise on the upside.

Scenarios have evolved from fear of hard landing to hope of soft landing to the new reality of no landing. US growth is robust, the labour market continues to be tight, and inflation is becoming stubborn at lower levels.

Market expectations of rate cuts have continuously trended down from six at the beginning of this year to two rate cuts now. The market now feels that the rate cuts will be back-loaded with the first cut coming perhaps only in September.

Consequently, the US bond yields shot up. The 10-year yield has spiked from around 3.82 percent in early February to above 4.6 percent by mid-April.

Domestic investors, not FIIs, are calling the shots now

Rising US bond yields trigger foreign portfolio outflows from emerging markets like India. Yield around 4.5 percent from the safest asset class in the world is a strong attraction for foreign portfolio investors.

selling impacts the Indian stock market pulling it down. But the traditional correlation between FPI selling and the Indian market trend is no longer as strong as it used to be. FIIs are no longer the powerful market players that they were in the past. Now the market is dominated by DIIs, Indian HNIs and retail investors.

In the tug of war between FIIs and DIIs the latter has been winning consistently. This new trend of Indian investors calling the shots is a healthy and positive development. Domestic money is more stable than FPI, which is hot money.

Sustained FPI selling provides opportunities to domestic investors. FPI behavior is excessively influenced by external factors. When US bond yields rise, they sell in emerging markets.

FII’s major holdings are in largecaps and, therefore, large scale FII selling puts pressure on largecaps making their valuations attractive.

Indian economy doesn’t need a monetary stimulus now

In India inflation is trending down. March CPI inflation declined to 4.85 percent. More importantly, the core inflation is only 3.3 percent. MPC’s inflation projection for FY25 is 4.5 percent.

Since the inflation rate is within ’s tolerance band, the MPC can afford a rate cut. But the growth momentum in the economy is strong and RBI’s growth projection for FY25 is 7 percent.

As the RBI Governor observed, “the capex cycle is getting broad based and capacity utilization is improving.” High frequency indicators point to sustaining growth momentum in the economy.

In this optimistic scenario, the MPC will not be in a hurry to cut rates. The fact is that the Indian economy doesn’t need a monetary stimulus now and, therefore, policy rates are likely to remain high for a few more months. Rate cuts by MPC this year, if at all it comes, is likely to be back-loaded.

(The author is Chief Investment Strategist, )

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