Markets are now pricing in 50bps US Fed rate cut in 2023: Chris Wood

The US Fed raised the target range for the federal funds rate by another 75 bps to 2.25-2.50 per cent in its July meeting. The FOMC statement has downgraded its assessment of the economic situation

Markets are pricing in a 50 basis point (bps) rate cut by the US Federal Reserve (US Fed) in 2023, wrote Christopher Wood, global head of equity strategy at Jefferies, in his recent note to investors in GREED & fear. The issue for markets in the medium-term, he said, remains whether the US Fed really intends to try and get inflation back below 2 per cent or whether it will in due course signal a more pragmatic (i.e. more flexible) approach to that 2 per cent target.

“Markets are now pricing in 50bps of rate cuts next year after the federal funds rate peaks at 3.25 – 3.5 per cent in early February, or 100bp above the current level. All this and more may in due course come to pass. Still in GREED & fear’s view, markets have got well ahead of themselves, while a series of Fed governors have begun to make speeches in recent days in a seeming effort to correct the overly dovish impression that Powell may have created. The latter outcome is still GREED & fear’s base case,” Wood wrote.

On its part, the US Fed raised the target range for the federal funds rate by another 75 bps to 2.25-2.50 per cent in its July meeting. The FOMC statement downgraded its assessment of the economic situation and admitted that recent indicators of spending and production have softened, while they repeated that job gains have been robust in recent months and the unemployment rate has remained low. The US central bank, analysts said, has left the door open for 25, 50, 75 or 100 bps rate hikes in its September policy review.

“Until inflation has come down to 2 per cent, slashing policy rates back to the zero bound is no option. At present, getting inflation back to 2 per cent is more important to the FOMC than keeping the economy afloat. A recession is basically collateral damage in the Fed’s mission to stamp out inflation,” wrote Philip Marey, senior US strategist at Rabobank International in a recent note.

The stock markets, meanwhile, have been on a run in the last one month. The S&P 500, Dow Jones Industrial Average (DJIA) and the tech heavy NASDAQ have gained 6.4 per cent, 4.3 per cent and 9.9 per cent, respectively in the last one month. Back home, the S&P BSE Sensex has rallied 7.6 per cent during this period.

Though the valuation of the Indian markets have come off peak levels, analysts at Motilal Oswal Securities suggest India still trades at a premium to global peers. This, they believe, offers limited upside in the immediate term.

“In price-to-earnings (P/E) terms, the MSCI India index is trading at a 116 per cent premium to the MSCI EM index, above its historical average of 62 per cent. With the current rally, Nifty now trades at 20x FY23 earnings, comfortably above the long period average and offers limited near-term upside. The upside from here will be a function of stability in global and local macros and continued earnings delivery versus expectations,” analysts at Motilal Oswal Securities wrote in a recent report.

What next? 

• The Fed has left the door open for 25, 50, 75 or 100 bps rate hikes in its September policy review, say analysts
• A recent FOMC statement had downgraded its assessment of the economic situation
• Until inflation has come down to 2%, slashing policy rates to zero may not be an option
• Even if the valuation of the Indian markets has come off peak levels, India still trades at a premium to global peers