How inflation and interest rates are shaping investment strategies in US

The Federal Reserve's recent decision to lower interest rates marks a significant departure from its previous tightening measures. This pivotal shift in US monetary policy has important implications for Indian investors with exposure to the US market.

Inflation has surged in recent years, leading the Federal Reserve to implement interest rate hikes to control rising prices. These hikes made borrowing more expensive, cooling down the economy and impacting consumer spending.

For Indian investors, this creates a tricky scenario. Inflation erodes the purchasing power of money. When inflation in the US rises, it often means that the real returns on investments—like stocks and bonds—drop significantly compared to nominal returns. This decline in real returns can make investments feel less rewarding.

Interest rates play a pivotal role in shaping asset prices and influencing investment strategies.

As interest rates rise, the cost of borrowing for corporations rises, and corporate profitability is squeezed. Companies face higher input costs, which can lead to lower margins and ultimately reduced earnings, reflecting negatively on stock valuations

Historically, rising interest rates have led investors to prefer safe, short-term instruments like bonds or cash, which offer higher yields. However, with the recent rate cuts, yields on these instruments are dropping. This shift pushes investors to explore more attractive options, creating opportunities for reallocating into US stocks, alternatives, and high-yield bonds.

But that’s not all. Currency fluctuations between the Indian rupee (INR) and the US dollar (USD) add another layer of complexity for investors. When the USD strengthens—often a result of interest rate hikes—it can lead to higher returns for Indian investors when profits are converted back to INR. However, if the USD weakens, those returns can diminish, complicating the investment landscape further.

After rate cuts, equities, particularly dividend-paying stocks, tend to outperform. Lower borrowing costs allow companies to invest in growth, making stocks more appealing compared to bonds. If you’re looking to take advantage of this trend, now might be a good time to consider US stocks.

Several sectors could benefit from this changing landscape. Defensive sectors like Healthcare, Consumer Staples, Utilities tend to do well post the interest rate cut. As borrowing costs decrease, growth stocks and US large-cap equities may experience a boost.

ETMarkets.com

ETMarkets.com

However, lingering inflation concerns remain, and the extent of the Fed's rate cuts will depend on broader economic conditions, including recession risks.

For Indian investors managing both rupee-based and dollar-based portfolios, staying vigilant is essential. In a “no-recession” scenario—which many analysts believe is possible—equity markets, particularly dividend-paying stocks, will likely remain attractive. Maintaining exposure to both US and Indian markets can help capitalize on reduced volatility in a post-rate cut environment.

In the long run, despite a short-term dip in cash yields, the long-term benefits of Fed rate cuts typically lead to more favorable equity markets, especially when inflation is under control. As you navigate this evolving landscape, remember to keep these dynamics in mind. They could significantly shape your financial future.

(The author Viram Shah is CEO, Vested Finance. Views are own)