India’s benchmark Nifty future crashed 200 points intraday despite a 25bps rate cut by the Federal Reserve. So what really went wrong, why did markets fall, despite the rate cut? Let us first understand that a rate cut is a tool used by central banks to boost growth by bringing down the cost of credit. This spurs growth and creates upside pressure in inflation numbers. Ideally, markets should witness a buying rally. Why was it different this time?
The Rate Cut Miscalculation
In order to understand what went wrong, we need to focus on the objectives of a Rate Cut and how the Fed plans to achieve those objectives. At the onset we must know that the Fed Funds Rate helps maintain stability of the US economy and propel it towards a growth trajectory. Therefore a rate cut is an act of lowering the cost of credit to push up the demand curve. The purpose is to balance the economy and the stock market by creating a win-win situation for business borrowings and equity investors at the same time. This is where the miscalculation happened.
Why Did Nifty Fall?
Today’s plunge of 197 points in Nifty can be directly linked to the Fed’s foggy stance in its forward guidance.
Surprisingly, the Central Bank stated that yesterday’s rate cut was one off, and was rolled out to absorb shocks stemming from factors like “weak global manufacturing”, “trade policy uncertainty (US-China)” and “muted inflation in the US economy”. The rate cut, it said was not aimed at spurring future growth. This caused the market makers to discount the move as a preventive measure and not a permanent cure and triggered selling.
Secondly, the Fed lacked clarity in its assessment of the US-China trade tensions. It failed to underline the probable solutions in terms of monetary policy restructuring. The central bank also stated that the US-China trade war was a rare phenomenon; hence it lacked the experience to deal with such uncertainty and was still in the learning phase.
The third and the last nail in the coffin were hammered when the Fed stated that weakness in Global Manufacturing data in countries like China and Europe were caused by periodic rotations of the business cycle. This was read as possible indication of recession by the market.
Trading Without Predictions
Trading can be very rewarding if we avoid predictions and follow the institutional traders during mega events like the FOMC policy. Most traders would pop question like, what if I miss out. The answer is, stop spinning those unnecessary ideas in your mind. Simply avoid building positions when the market makers do not participate. In today’s session for instance, it was very simple to execute shorts. The Fed rate cut was laced with negatives. All we needed was a gap down opening and the arrival of the binomial price. Once the binomial price triggered, we went long in 10800 Put options. The 10800 Put was bought at Rs72.50 and Nifty plunged 197 points intraday. The Put was later squared off at 106.