Can US Federal Reserve’s revised rate cut outlook accelerate FII outflows from Indian stock market?

The US Federal Reserve’s recent monetary policy decisions have sparked widespread debate about their implications for global markets, including India. With a 25 basis points (bps) rate cut in December 2024, the Federal Open Market Committee (FOMC) has brought the benchmark rate to 4.25-4.5 per cent. 

While this move aligns with market expectations, the Fed’s hawkish outlook for future rate cuts has raised concerns about reduced foreign inflows into Indian markets. Experts predict that these developments could introduce fresh volatility, affect capital inflows, and challenge investor sentiment.

Fed’s Hawkish Turn

The Fed’s December policy decisions signal a cautious approach. Fed projected just two rate cuts in 2025 and another two in 2026, as opposed to the September dot plot that anticipated four cuts in 2025. This stricter stance is attributed to persistently low unemployment rates and sticky inflation, which have tempered expectations of aggressive monetary easing.

US Fed’s cautious approach hurts Indian markets

Indian stock markets faced a sharp decline on Thursday, December 19, dropping around a per cent after the US Federal Reserve signalled a slower pace of rate cuts in the future. The downward trend persisted on Friday, December 20, with the benchmarks shedding another half a per cent during intra-day trading, marking the fifth consecutive session of losses.

V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, noted that while the 25 basis points rate cut aligned with market expectations, the Fed’s projection of only two rate cuts in 2025—compared to market expectations of three or four—triggered a sell-off on Wall Street, influencing global markets.

Foreign Portfolio Investors (FPIs) sold ₹922 crore worth of Indian equities in the previous session, a trend expected to continue amid a strengthening US dollar, rising bond yields, and reduced prospects for rate cuts by the Fed next year. Additionally, the Indian rupee hit an all-time low of 85.34 per dollar, further dampening market sentiment.

Expert Opinions

Experts warn that this hawkish stance could further dampen investor sentiment, reduce foreign capital inflows, and introduce significant volatility in Indian markets. However, amidst the challenges, sector-specific opportunities and a long-term growth story remain bright spots for discerning investors, they added.

Market Outlook

According to Swapnil Aggarwal, Director, VSRK Capital Fed’s rate cut outlook could make Indian assets less attractive to foreign investors, potentially leading to capital outflows. 

“Additionally, the rupee’s continued decline to new lows has further soured sentiment. A prolonged depreciation of the rupee could exacerbate the trade deficit and heighten inflationary pressures in the future,” he explained.

Subho Moulik, Founder & CEO, Appreciate echoed similar views, suggesting that the Fed’s decision to lower the number of anticipated rate cuts may put Indian equity investors on edge.

The potential for reduced foreign capital inflows is a concern, as the US debt market, with its more attractive returns, becomes a stronger alternative, he said, adding that this could spark a pullback in the market in the near term.

Investment Strategy

Amid the uncertain market environment, Moulik advised investors to opt for large-cap stocks as they are often seen as a safe bet. However, with FIIs typically invested more in the larger Indian companies, these stocks may not be entirely insulated from potential outflows, he said. 

“Investors may need to consider sector-specific strategies. Export-oriented sectors, such as IT and pharmaceuticals, can be pockets of strength. They could provide a greater margin of safety during this time. As for mid and small caps, they are already at somewhat elevated valuation levels. That said, the blip is not a structural one. The India growth story is a long-term play. The market will eventually catch its breath, offering savvy investors a chance to buy quality companies on the dip,” added Moulik.

Justin Khoo, Senior Market Analyst – APAC at VT Markets, anticipates that export-oriented sectors like IT will gain, as the Fed’s expected rate cuts could further weaken the rupee, benefiting these sectors.

Interest-rate-sensitive sectors like real estate, autos, and capital goods may underperform, while IT and export-oriented sectors stand to gain from a stronger USD, he remarked. Khoo also warned of inflationary pressures negatively impacting consumer sectors, contributing to heightened market volatility and cautious investor sentiment.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.