Fall in Fed funds rate can be great for India

Understanding the Relationship Between Fed Funds Rate and Commodities

A recent analysis by Zafar Shaik of Invesys Capital highlighted the relationship between the Fed funds rate and key commodities like crude oil and copper. This relationship is crucial because it gives insights into how the commodities market might behave in response to changes in interest rates. The Fed funds rate, which is the interest rate at which banks lend to each other overnight, has a significant impact on the broader economy, including commodities.

Fed Funds Rate Cuts and Their Impact

The analysis looked at four different periods when the Fed funds rate was cut—during the 1990s, from 2001 to 2008, and in 2020. Each time the Fed funds rate was reduced, it had a noticeable effect on commodities like crude oil and copper. For example, during the first instance, crude oil prices remained flat as the Fed funds rate was cut. In later instances, crude oil prices initially dropped when the Fed funds rate was reduced but then rose sharply as the rates stabilized and started to increase again. This pattern suggests that while rate cuts might initially lead to lower commodity prices, a stable or rising rate environment can drive those prices back up.

Crude Oil and Its Future

Looking at crude oil specifically, the pattern has been clear. Each time the Fed funds rate was reduced, crude oil prices tended to fall. However, once the rates stabilized, crude oil prices rebounded. As we might be on the verge of another rate cut, there is a possibility that crude oil prices could drop again. This potential decline in crude oil prices could be very beneficial for countries like India, which rely heavily on imported oil. Lower crude oil prices could reduce costs for many industries and consumers, providing a boost to the economy.

Copper and Industrial Commodities

Copper, which is often seen as a proxy for industrial commodities, has shown a similar pattern to crude oil in response to Fed funds rate changes. In the current cycle, copper has performed well, but if it follows the pattern seen in previous cycles, it might also experience a downturn if the Fed funds rate is cut. A drop in copper prices could be a positive sign for industries, as lower raw material costs could lead to better profit margins.

Positive Signs for Manufacturing

If both crude oil and copper prices decline, coupled with lower interest rates, it could create a favorable environment for the manufacturing sector. Lower costs and cheaper borrowing rates could encourage businesses to expand and invest in new capacity, potentially leading to a manufacturing boom. This scenario could provide a strong tailwind for economic growth, especially if interest rates remain low for an extended period.

The Uncertainty Ahead

However, there is still uncertainty about how quickly and how much the Fed funds rate will drop. If the rate cuts are shallow and short-lived, it might not provide the expected benefits to the market. On the other hand, if the Fed funds rate drops significantly and stays low for a while, it could lead to a more sustainable recovery in the commodities market and broader economy. The next few months will be critical in determining the future direction of the market.

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