Imagine you are swimming in the ocean. You are a strong swimmer (a great company). But if the tide goes out (Macroeconomics), even the strongest swimmer will be pulled away. Conversely, "a rising tide lifts all boats," even the leaky ones.
In the world of investing, Macroeconomics is the tide. And the organization that controls the tide is the Federal Reserve (The Fed) of the United States. You might live in Mumbai or Tokyo, but the decisions made by a committee in Washington D.C. have a bigger impact on your portfolio than your local government's budget.
This module demystifies the "invisible hand" that moves markets globally.
1. The Federal Reserve: The World's Central Bank
The US Dollar is the global reserve currency. Oil, Gold, and international debt are priced in Dollars. Therefore, the entity that controls the supply and price of Dollars effectively controls the global economy.
The Dual Mandate: The Fed has two jobs:
(Keep Low)
(Keep Stable ~2%)
*The Fed raises interest rates to lower inflation, but this often increases unemployment. It's a balancing act.
2. Interest Rates: The Gravity of Finance
Warren Buffett famously said, "Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices."
When the Fed raises the Federal Funds Rate (the base interest rate):
- Cost of Borrowing goes UP: Companies pay more interest on loans, reducing profits.
- Risk-Free Return goes UP: If US Treasury Bonds pay 5%, why buy a risky stock? Investors sell stocks to buy bonds.
- Discount Rate goes UP: Future earnings of tech companies are worth less today (DCF valuation model).
The Gravity Effect
When rates rise, the valuation multiple (P/E) of the market contracts.
3. The Domino Effect on India (FII Flows)
Why does the Indian market crash when the US Fed raises rates? It's about the flow of capital.
This illustrates why you cannot ignore the Fed. The RBI often has no choice but to follow the Fed's lead, even if the domestic Indian economy is doing well.
4. Inflation: The Invisible Thief
Inflation measures the rate at which prices rise.
• CPI (Consumer Price Index): What consumers buy.
• PCE (Personal Consumption Expenditures): The metric the Fed prefers.
When inflation is high (e.g., 2022), cash loses value. Investors demand higher returns to compensate. Stocks of companies with "Pricing Power" (ability to raise prices) perform well, while unprofitable growth stocks crash.
5. Quantitative Easing (QE) vs. Tightening (QT)
This is the "Liquidity" lever.
- QE (Printing Money): The Fed buys bonds from banks, injecting cash into the system. This cash finds its way into the stock market, inflating asset prices. (e.g., Post-COVID rally).
- QT (Burning Money): The Fed sells bonds or lets them expire, sucking cash out of the system. This reduces liquidity, making markets volatile.
6. The Yield Curve: The Recession Predictor
Normally, 10-year bonds pay higher interest than 2-year bonds (because you lock money for longer).
Sometimes, the curve Inverts (Short-term rates > Long-term rates).
Meaning: Investors expect the economy to break in the future, forcing the Fed to cut rates later. An inverted yield curve has predicted almost every recession in the last 50 years.
If the Fed is cutting rates and printing money (QE), be bullish. Buy stocks.
If the Fed is raising rates and sucking liquidity (QT), be defensive. Hold cash or quality value stocks.
Trying to short the market during QE or go long during aggressive QT is usually a losing battle.
Summary of Module 5
Macroeconomics is not just academic theory; it is the operating system of the global market. The US Federal Reserve sets the global cost of capital. When money is cheap, it flows to India and Tech stocks. When money is expensive, it flows back to US Treasuries.
While equities are affected by rates, there are other asset classes that react differently. In the next module, we will explore the tangible world of Commodities (Gold & Oil) and their role in a global portfolio.