How to play the Interest Rate Game: 3 Rules to Keep in Mind Today
It’s an all too familiar story.
When any major event occurs with the US Fed- such as an interest rate decision, a GDP announcement, or practically any words uttered by the Fed Chairman, Janet Yellen- India’s economy reacts swiftly.
And the the absolute first indicator is reflected through higher volatility in the stock markets.
You might be wondering: why would India’s stock markets react to a decision by the US Fed on interest rates? The answer has to do with how we, the collective Indian population, feel how the Reserve Bank of India will react to the Fed’s decision. In today’s case, the Fed decided to not raise its baseline interest rate from 0% (it has been at 0% since 2008) despite some speculation that the Fed might raise rates. This now leads to speculation on how the RBI will react on 29th September when RBI Governor Raghuram Rajan decides whether or not to cut the headline repo rate from its current 7.25%.
How to Play the Interest Rate Game
OK, so we know that Fed did not raise rates. We also know that because the Fed did not raise rates, this increases the likelihood of Governor Rajan cutting the repo rate in 11 days from 7.25% to 7%. GDP has been sluggish and the economy needs a push. The easiest way to do this is by cutting the headline interest rate, provided that inflation is under control. Well, what do you know- inflation is well under control.
The real question is this: how does this affect you, the trader/investor? Should you hold on to your positions? Should you look to play the volatility game, looking to quickly get in and out of trades during the trading day due to higher volatility? Should you enter new positions and hold them long term? So many questions!
Here’s how to play the game.
- Expect higher volatility. Therefore, if you are an intraday trader- look to maximize on opportunities for quick entries and exits. You’re purely looking to play on volatility. When the markets are volatile, you can earn handsome profits by keeping a strict stop loss, never being over exposed on any one trade, and by maintaining a clear profit objective. Risk management is key.
- Lower interest rates = higher growth and higher inflation. This is Economics 101. Therefore, now that the US Fed did not raise its interest rate, it increases the probability that the RBI will cut rates. Cutting rates = higher growth. Higher growth is reflected through…you guessed it, a surge in the stock markets.So does this mean that the markets will trend up today? Not necessarily. Since the US did not raise rates, some economists might look at this as a sign of weakness for the US economy, which might signal further sluggishness for the Indian economy since India’s economy is so highly interlinked to the economy of the US. Economists might also fear that this gives China more credibility, leading to a paranoia effect that our economy is more dependent on China’s economy than ever before.
However, those are all theoretical possibilities. One thing is certain: all factors remaining the same, when a country cuts interest rates, its economy grows. Therefore, the markets should surge upwards.
- Wait for the correct opportunity to hop on the boat, but don’t miss the boat. Patience is key when markets are unpredictable and volatility is high, but fear of missing out (FOMO) can kill your chances of taking advantage of situations like today. If you’re an investor, look for undervalued stocks and a clear signal that the RBI is leaning towards a rate cut. If you’re a day-trader, look for opportune times to get in and out of trades. Liquidity will be high due to higher volatility, so it’s just up to you on how well you’re able to time and place your trades.
And always remember: risk management is key! Never over expose yourself to any single stock, sector, or asset class. And always ensure that you’re trading through a secure, high speed internet connection.
Best of luck! Feel free to post any questions you may have in the comments section 🙂