Why Interest Rate hikes and cuts shock and rock the stock markets

Blog | imported-posts

At 11am today, the RBI will be making its interest rate decision on the headline repo rate.

On 18th December of last year, we were in a very similar position.

The markets were expecting the RBI to cut its headline interest rate from 8% to 7.75%; however, RBI Governor Raghuram Rajan shocked the markets by keeping the rates unchanged

The result? The Sensex surged by almost 300 points that day alone. The markets had priced in the information that a rate cut was going to happen, but when the RBI announced that a rate cut would not happen, the markets surged.

The natural question arises: what caused the surge?

Incredible Volatility

On days when the RBI makes interest rate decisions, the markets are marked by heightened volatility. In fact, apart from Budget days, days on which interest rate decisions are made are the most volatile.

Expect a lot of volatility today around 11am.

As of now, most economists are expecting the repo rate to remain unchanged. If the rate remains unchanged, the markets should surge upward. This is due to the following reasons.

  1. With the RBI holding on to a high interest rate, it shows that the RBI has faith in the economy. It shows that the RBI feels it does not need to interfere (cut the interest rate) in order to boost the economy.
  2. It ensures that FII's still look to India as a favorable destination for investments.
  3. Perhaps, above all, it sends a strong signal to the world that the RBI wants the markets to govern themselves.

That being said, there is some speculation that the RBI will cut rates today due  to the fact that the macro economic fundamentals of the economy seem to suggest that a rate cut is warranted. Due to low inflation, the RBI can afford a rate cut. Furthermore, while Friday's GDP beat expectations, the government seems keen to get our GDP above 6%.

A rate cut would definitely provide a boost to the economy. Therefore, we cannot rule out the possibility of a rate cut.

Watch out for a lot of volatility from 10:45am onward. Avoid placing fresh positions around the time of the decision, but at the same time, look for opportune times to take advantage of the high volatility to make quick, intraday trades.

Tread carefully!


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