FED INTEREST RATES: {AN IMPORTANT INDICATOR OF MARKET DIRECTION}

One can have a look on the amazing history of Fed interest rates “Fed interest rates hovered near 1 % in 1954 and, it went skyrocketing in 1981 to more than 15% and recently the Fed lowered it to 4.75% on Sep 18, 2007 from earlier 5.25%”

The Federal Reserve is often referred as the “Fed”. It is the central banking system of the U.S. The Federal Open Market Committee (FOMC), a component of the Federal Reserve System, is charged under U.S. law with overseeing open market operations in the United States, It is the principal tool of US national monetary policy. The FOMC meets eight times a year, mainly in Jan, Mar, May, June, Aug, Sep, Oct and Dec. Minutes of regularly scheduled meetings are released to the public, three weeks after the date of the policy decision. The Fed funds rate, was at a forty-six year low of 1% ,when rate hike campaign started in June 2004, since than the interest rate has been increased seventeen times and reached 5.25%.But on Sep 18, 2007 Fed paused rate hike campaign by reducing the rate by 50 basis point to 4.75%.

Effect of Fed rate cut on Precious Metals: -If we look back to the historical highs of Gold in 1980,we can notice that at Crude Oil prices were hovering at $21 a barrel because Iran was invaded by Iraq. Precious metals tend to boom in time of geopolitical tensions. Higher Crude prices spurred inflation in U.S to 13.58 per cent. While Fed interest rates zoomed up more than 15 percent. It hovered in the $500 vicinity on that same April 2nd 1979, after setting the current $850/oz record on January 21, 1980 (thereby smashing the $500, $600, $700 and $800 barriers in one go). So both Gold and Fed interest rates peaked at same time. When the Fed announced the interest rate cut to 4.75 % from earlier 5.25% on Sep 18, 2007 Gold sky rocked and hit a 27-year high because the decision exerted more pressure on Greenback. Generally, investors invest in Gold to Hedge against currencies and inflation.

Effect of Fed rate cut on Base metals: -Base metals welcomed the recent rate cut by Fed gracefully with full enthusiasm. U.S economic health plays a key role in the global economy. The recent Fed move, gave an added boost to the metals market, the rate cut by the Fed will increase the liquidity in the market, thereby the overall economy will get boost as people will start spending more as a result the manufacturing sector will get boost thereby inducing more demand for base metals. Already industrial metal consumption is ever increasing and is expected to remain stronger in near future. Copper and other base metals witnessed upward movement , which relieved fears that faltering US economy could cut demand for the metals. The rate cut decision weakened the ailing US currency, making dollar-denominated metals cheaper for the holders of other currencies.Demand for Copper in cable industries, power grid and construction material is gaining sharply in Asian markets where the economy is growing at a faster pace. Also to note that Commodities and equities have been surging for years on rising demand from emerging markets in places like China and India. Demand for industrial metals are closely linked to global growth prospects.

Effect of Fed interest rates cut on Crude oil: – The recent decision taken by the Fed to reduce the interest rates by a larger than expected half percentage point, have positive impact on the economy because it will accelerate economic growth and thereby lift the demand of Crude oil. It will have bullish impact on the prices as Crude oil and Gasoline in which inventories are already running tight ahead of winter season in U.S.due to the recent disruptions by Hurricane.

Effect of Fed interest rate cut on Currencies: -The aftermath of Fed interest rate cut is that US dollar dropped against most of the major currencies, and we have seen a new record level for the Euro. The Euro has reached lifetime high level of 1.4120, and has kept the door open to test higher levels. The Canadian dollar has bursted through parity with the US dollar for the first time in 31 years. The Swiss franc has reached a two-year high of 1.1676, while the Japanese yen range traded between the 114–115 levels. Indian Rupee also breached its 40 level on back of weak Dollar, as a result importer will make merry while exporters will suffer.

Effect of Fed rate cut on Indian Economy: -A rate cut in the US in current environment holds significant implications for emerging markets such as India. We are witnessing a fresh flood of capital inflows, which resulted in massive bull run in the Indian stock markets as Sensex surged to lifetime high levels of 17000.But on the other side it will also complicate monetary and inflation management for the Reserve Bank of India.

Bankers expect the Reserve Bank of India to soften its view on interest rates in the light of the US Federal rate cut. As a result domestic loans and overseas borrowing may become cheaper. It is to note that Indian financial system is driven more by the domestic factors; But Fed rate cut might be one of the triggers to review rates. There may not be direct correlation between the US Federal Reserve action and the RBI’s moves. But, currently, India is witnessing huge capital flows in the capital market, which has implications on exchange rate or the value of Rupee and relative difference in interest rates. Thus RBI has to go for a tightrope walk to avert sudden appreciation in value of the Rupee versus Dollar. Another factor that weighing on the RBI’s mind is the fact that the elevated domestic interest rate may attract funds further to take benefit of rate arbitrage thereby increasing more inflows .RBI may not follow Fed Reserves footsteps immediately but eventually will take cue and change monetary policy stance.

Effect of Fed rate Cut on Credit Crunch: -Recent Fed move is begining to ease tightness in the credit markets and bringing greater stability to financial markets, which have been periodically slowed down by rising defaults on sub prime mortgages and housing market weakness. The recent rate has infused liquidity into the market. As a result consumers purchasing power got boost by seeing lower interest rates on debt such as credit card.While the boost to investor confidence was quite immediate after Fed cut as a result the NASDAQ and Dow jones in U.S along with Asian stockmarkets scaled higher. As far as slowdown in the housing sector is concerned, weakness in the housing sector isl likely to remain at present because Fed interest rate moves often take six months or more to fully percolate them in the economy. The major benefit of the Fed rate cut is that it will avoid wave of foreclosure because nearly 2 million homeowners in U.S face sharply higher mortgage payments when their current loans reset over the next year. The ripple effect of the Fed action is that interest rates will drop on a variety of loans, which will effect the borrowers.

Effect of Fed rate cut on Global stock markets: -Major global stock markets surged after the Fed interest rate cut decision. Here, we have a glimpse of the movement of major indices worldwide.Dow Jones ,the blue chip index surged to 13,079.1 only about 1.9 percent below its record close of 14,000.41 reached in mid-July. Hang Sang Index in Hong Kong rose 4 per cent to a record close of 25,554.64, Japan’s Nikkei closed up 3.7 per cent – its biggest one-day percentage gain in more than five years. Indian BSE Sensex also witnessed biggest ever-single day gain of 654 points as it closed up by 4.17 per cent at 16322.75.Now the Indian BSE Sensex has also breached 17000 levels.