A mid-year recession in the US may be good for stocks — here's why

Robert Sockin, a Global Economist at CITI, told CNBC-TV18 that CITI predicts there will be five cuts in US interest rates this year, each being 25 basis points, starting in June.

Rate cuts are important for equity markets worldwide, more so in India, where the stake of foreign portfolio investors has fallen below that of domestic mutual funds and retail investors for the first time. Indian traders would welcome the dollars returning to Dalal Street.

The first of five cuts projected by CITI will be in June 2024 because the US Federal Reserve expects a mid-year recession in the world's largest economy, prompting more rate cuts later to revive the economy, according to Sockin.

FILE PHOTO: US Fed Chair Jerome Powell

However, many others like the Deutsche Bank don't expect a recession this year. If the recession-denier are right, it may take longer for the US inflation to return to the Fed's target level of 2%. That's bad news for global equity markets.

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“It may be more stubborn in certain components than expected and even if you are getting growth that's continuing at a moderate pace, in that environment of a soft landing, the Fed is likely to cut rates even more cautiously, maybe even something like the three times that they signalled in their Summary of Economic Projections (SEP) forecast,” he added.

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On February 13, the US Labor Department data showed a 0.3% increase in consumer price index from December to January, faster than 0.2% rise a month earlier.

The January 2024 price rise in the US was 3.1% compared to a year earlier. The Federal Reserve's target is 2%.

A stubbornly high inflation is bad for President Joe Biden who will seek voters' assent for a second straight term in office later this year.

When the American central bank cuts interest rates, the move releases more money into the market, some of which would find its way into risky bets like stocks.

Lending rates would also fall following the rate cuts in the US, bringing costs down for businesses and propping up both profits and, as a result, stock prices.

US interest rates also affect bond yields in the US and elsewhere. When interest rates are about to fall, the yields will typically start to soften, making other asset classes like stocks more attractive for investors seeking higher returns.

However, stock market traders start pricing the impact of such rates before they happen.

Like the US, the Reserve Bank of India is also waiting for inflation to cool off to its target level of 4%. However, as it seems to be, RBI's projections show that retail inflation in India may remain well above 4% through the rest of 2024.

But if there's a recession in the US and prices for key global commodities start declining, it may help ease the pinch in India, too. And if inflation in India is back to manageable levels, it may prompt the RBI to bring the benchmark repo rate down.

In summary, while many other factors are at play, falling interest, in theory, rates boost stock prices. Those ahead of the curve will start investing before the tide turns.

When will interest rates turn? Sooner, if there's a recession in the US. Later, if there isn't one.

For the entire interview, watch the accompanying video