US Federal Reserve Cuts Policy Rate, Signals Cautious Outlook; Indian Equities Expected to Benefit

The US Federal Reserve has lowered its policy rate to between 3.75% and 4%, noting that inflation risks have diminished and the labor market remains stable. This move effectively signals the end of quantitative tightening (QT), which typically implies lower bond yields.

However, Federal Reserve Chair Jerome Powell's remarks led to an upward shift in the treasury yield curve. He indicated that there are differing opinions within the Federal Open Market Committee (FOMC) regarding future policy actions, with some members favoring a pause to await more clarity on inflation and employment data. This uncertainty caused the equity market to decline and the dollar index to strengthen.

Powell expressed comfort with lower-than-expected goods inflation since April and suggested that core PCE inflation, even excluding tariffs, is close to the Fed's 2% mandate. The labor market is described as delicately balanced, influenced by demand and supply factors, with jobless claims data indicating overall stability, though some distress is noted at lower income levels.

The Fed's balance sheet will effectively freeze after $2.4 trillion in QT over 3.5 years. Reinvesting mortgage-backed securities pay-downs into Treasuries will help absorb government debt issuance and limit auction volatility.

Impact: For Indian equities, the news is positive, suggesting a continuation of tactical rebounds and reversal of underperformance. The valuation gap between the S&P 500 and the Sensex has narrowed, making Indian markets relatively more attractive. However, global factors like the trade war and massive AI capital expenditure investments by tech giants (Magnificent 7) could pose challenges. AI capex, estimated to exceed a trillion dollars by 2026, is a significant, albeit debated, driver of US GDP and market valuations, potentially masking underlying economic weaknesses. Investors are advised to focus on "Picks and Shovel" plays related to AI and other long-term themes like Defence, Make in India, and Healthcare. Rating: 8/10

Difficult Terms: * **Quantitative Tightening (QT)**: A monetary policy tool where a central bank reduces the size of its balance sheet by selling assets or letting them mature without reinvestment, thereby reducing the money supply. * **Treasury Yield Curve**: A graphical representation of the yields of U.S. Treasury securities with different maturities. An upward shift means yields on longer-term bonds have increased. * **FOMC (Federal Open Market Committee)**: The primary monetary policymaking body of the U.S. Federal Reserve. * **Core PCE Inflation**: Personal Consumption Expenditures price index excluding volatile food and energy prices. It is the Fed's preferred measure of inflation. * **MBS (Mortgage-Backed Securities)**: A type of asset-backed security that is secured by a mortgage or a collection of mortgages. * **AI Proxies**: Companies or investments that are expected to benefit from the growth of Artificial Intelligence, even if they are not directly AI developers. * **S&P 500**: An index that tracks the stock performance of 500 of the largest companies listed on stock exchanges in the United States. * **Sensex**: The benchmark index of the Bombay Stock Exchange, representing the performance of 30 large, well-established, and financially sound Indian companies. * **Magnificent 7**: A group of the seven largest and most influential technology companies in the US: Apple, Microsoft, Alphabet (Google), Amazon, Meta Platforms (Facebook), NVIDIA, and Tesla. * **GDP (Gross Domestic Product)**: The total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. * **"Picks and Shovel"**: A strategy referring to investing in companies that provide the tools and infrastructure necessary for a booming industry, rather than the industry itself. For AI, this could mean companies providing data centers, power, or specialized hardware.