US Interest rate cuts: What it means for global markets; will Indian markets rally?

The US markets have led a relentless rally in the past year despite a steady rate for the same period. Now with at least three rate cuts on the horizon, the emerging markets too are poised for strong outperformance. Historically, Indian markets too have shown high outperformance over their global peers when US interest rates are on a downward trajectory. The Federal Reserve will announce its much-anticipated policy decision on 17th September as the US economy grapples with high unemployment headwinds. The latest labour market data showed that the US economy added 22,000 jobs in August, the lowest since October 2021. In addition, the latest revisions of the data for June showed that the US economy removed 13,000 jobs, the first time since December 2020. The weak labour data will remain a larger contributing factor to the Fed’s policy decision, despite the headline inflation above the target range of 2%. The CME Fed funds futures indicate a 96% probability of a 25-basis-point cut in the interest rate at the current meeting. The interest rates were kept unchanged for a period of over 9 months after being cut by 100 basis points. Federal Reserve officials were cautious about rising inflation due to tariffs, which kept them away from cutting interest rates much earlier. However, the rising unemployment numbers prompt swift action by the Federal Reserve in the coming policy meeting and the meetings after that. Various economic polls and survey’s including Bloomberg, Reuters and analyst expectations at J.P. Morgan and Morgan Stanley, show high chances of three more rate cuts by the end of December 2025. Rate cuts in general are positive for markets as it inject liquidity into the system that leads to rising investments and buoyant economic activity. Historically, the US markets have performed in the high double digits post-12 months of the rate cuts. The US markets are currently trading at record high levels, led by the Artificial Intelligence boom. On the other hand, the other global EM peers have underperformed the US markets by a wide margin. With at least three rate cuts on the horizon, how will the global markets react to the new liquidity influx? Here are the top factors that could influence the high outperformance of Indian markets Reforms Historically, the data shows, emerging markets have led with massive outperformance over the benchmark US indices as a cheaper cost of capital creates a risk-on environment amongst the global investors, which leads to a massive flow of capital into the emerging markets. Among the emerging markets Indian markets have led with 10-16% gains over a period of 12 months after the rate cut cycle starts. The US markets have posted a relentless rally despite steady interest rates, concerns over high inflation due to tariff wars. Considering the underperformance of Indian markets, coupled with rate cuts, GST reforms, Indian markets could lead to a strong performance. Valuations The relentless rally in the US markets has led to massive surge in the valuations of the US markets. On the other hand, the Indian market’s valuations have remained stable and in a reasonable range. Dow Jones' current price-to-earnings ratio stood at over 25x, much above its historical averages of near 20x. Whereas NIFTY50’s current price-to-earnings ratio stands at 21x, which is closer to its historical average of 20x. The coming rate cuts might drive incremental flow to the emerging markets, especially India, which could outperform its peers, as it provides valuation comfort, high growth potential and reforms that could induce much-needed earnings growth. Breakthrough in tariff war Apart from the above two key factors, a probable breakthrough in the tariff situation between India and the US could possibly augment the global investor sentiment. Foreign investors are now holding Indian equities at 17-year low levels, making them highly underweight on India in the longest period, due to recent, relentless selling. The liquidity influx could find its way back to India if the major headwind of tariffs is cleared in the coming months. The recent Truth Social post by President Trump indicates some progress in the situation as both nations could engage in negotiating dialogues and provide a win-win situation for both nations.