Santa rally off a Fed New Year resolution

US Federal Reserve chairman Jerome Powell has sparked off - in what will surely be the most overused cliche of the month - a 'Santa Rally'. On Wednesday, the Federal Open Market Committee held rates steady at 5.25-5.5%. Committee members expect rates to be 4.6% (a range of 4.5-4.75%) by the end of 2024, and 3.6% by the end of 2025. This implies three-quarter-point rate cuts in 2024. This is because the Fed's expectation of core inflation is now 2.4% at the end of 2024, compared to 2.6% earlier. Importantly, Powell seemed to assign a greater importance to preventing a recession. Clearly, the Fed is prepared to cut rates even before the US CPI hits 2%. The markets chose to ignore caveats that the fight against inflation was not over, and further hikes could not be ruled out. The Fed is essentially catching up with markets, which had predicted that interest rates had reached the top. What is noteworthy is that Powell chose not to dampen expectations. On cue, the Dow closed above 37,000 for the first time.

The Indian markets have taken this as a license to soar, with the Sensex closing at 70,589 and the Nifty at 21,182. BJP's victory in the state polls and the consequent enhanced prospects of a stable reform-oriented government in May 2024 had enthused markets. The Fed's dovish stance has them firing on all cylinders. Going forward, prospects depend on a pickup in the capex cycle of which there are some indications. As per RBI, capacity utilisation is at 74%, which is above the long-period average, and sanctioned loans, a rough proxy for capex, is significantly higher than last year. The PLI scheme is gaining traction.

Indian stocks have always been richly valued. As net profits rise, multiples will fall, making them affordable, particularly for picky foreign investors. Also, the Fed's dovish stance could encourage RBI to start cutting rates towards the middle of the next fiscal, which would lend a helping hand to the much-delayed private sector capex cycle.