The Fed officially launched an easing cycle with a massive 50 basis point rate cut, well above the 25 basis point cut expected by financial markets.
Although the decision was not unanimous, with dissent within the committee for the first time since 2005, Chairman Jerome Powell said the economy was “fundamentally fine” and that the labor market was “in good shape” and that the unemployment rate was “very healthy”.
Crushing rumors of a weakening U.S. economy, Powell presented the rate cut as a sign of growing confidence in controlling inflation, a guarantee against job losses and a bold commitment to ensuring that the Fed is not “falling behind.”
The Fed’s goal, he said, is to keep inflation stable while ensuring unemployment rates don’t rise.
Although widely expected for September, the Fed’s first rate cut in years has sparked intense debate, with only one in ten economists surveyed by Bloomberg correctly predicting a 50 basis point hike. Most Fed watchers thought the economy’s continued strength warranted a cut of just 25 basis points.
For Seema Shah, chief global strategist at Principal Asset Management, the Fed’s decision to think big is “a unique decision in history.”
“No financial crisis brewing, no asset price bubble bursting, no job losses and a stock market that was already up some 18 percent since the start of the year. Powell’s positive interpretation of the economy makes the decision even more puzzling,” she said.
“Still, from an investor perspective, the main takeaway from today’s decision is that the Fed will make historic efforts to avoid a hard landing. With a series of rate cuts underway, the risk of recession has collapsed.
The Federal Open Market Committee (FOMC) is expected to cut another 50 basis points by the end of the year, then another 100 basis points in 2025, before making a final move of a half -point in 2026 to bring the rate between 2.75 and 2.75. 3 percent.
Still, Powell emphasized the Fed’s agility, making clear that if the economy remains resilient or inflation remains persistent, it will take a more cautious approach to cutting rates.
Furthermore, he added: “Intuitively, most – many, many people anyway – would say that we are probably not going back to those days when trillions of dollars of sovereign bonds were trading at negative rates, and where long-term bonds were trading at negative rates. »
Financial markets initially reacted to the FOMC decision with a cautious increase in risk appetite: the bond curve steepened with two-year yields falling and 10-year yields rose slightly. , while stocks saw a moderate recovery.
However, as the day progressed, the curve continued to steepen as two-year yields and equity markets gave up their initial gains.
In the face of these market changes, Stephen Miller, investment specialist at GSFM, highlighted ongoing inflation concerns and the looming challenges posed by the “gargantuan” US budget deficit. He highlighted the lack of concrete plans from both political parties to deal with its large-scale consequences.
“This raises the question of whether bond yields can rise significantly further – and certainly longer-term bond yields – despite the Fed being in easing mode, while markets suffer from indigestion associated with the need to financing these deficits with record bond issuances,” Miller said.
“It could also be said that markets are currently pricing in a very benign scenario and not only might they be vulnerable to negative risks, but they have reached a point where they are struggling to price in further good news.”
Looking ahead, Shah sees the diminishing risk of recession as a promising sign for risk assets.
“History suggests that the Fed’s success in leading a soft landing or a hard landing will play a key role in the direction of U.S. stocks. During easing cycles in which recession has been avoided and, as a result, earnings growth remains quite robust, equity markets generally respond positively,” she said.
“Since 1985, five of the ten best years for the S&P 500 have occurred when the Fed cut interest rates without a recession. The historical perspective should give investors some optimism about the future of the market.
Chris Galipeau, senior market strategist at the Franklin Templeton Institute, agrees that history points to strong upside ahead for the S&P 500.
“History tells us that when the Fed cuts rates amid an economic expansion, the S&P 500 rebounds an average of 16.66 percent in the 12 months following the initial rate cut,” Galipeau said.
“Since 1990, when the Fed cut rates, growth in large caps and small caps has generated the strongest performance in the 12 months following the initial rate cut.
“As a result, we view any pullback as a buying opportunity.”
Could the Fed inspire the RBA?
The government quickly dampened speculation about a similar move by the Reserve Bank next week.
Speaking to the media on Thursday, Treasurer Jim Chalmers said: “It’s really important to remember that rates have risen more in the US than in Australia and even after this overnight interest rate cut next day in the United States, interest rates are still higher in the United States. in the United States than they are here.
“When the Reserve Bank meets next week it will look at a whole range of things, including this, but it will focus mainly on inflation, as the Government does.”
Also making the media rounds on Thursday, Prime Minister Anthony Albanese noted that the United States was cutting interest rates due to a sluggish economy.
“Inflation has peaked higher in the United States and interest rates have peaked higher in the United States than here. They reduce a higher rate. Here we peak at 4:35 p.m.
“In most Western countries it was over 5 percent or much higher. And that’s what they had to deal with afterwards: in countries like the UK, we had double-digit inflation. So what we’ve done is try to manage the economy in a way that takes care of people along the way.
Chalmers and Albanese were not the only ones to moderate RBA expectations, reflecting the Fed’s rate cuts. Traders also downgraded their rate cut forecasts, with bond markets now pricing in a 79 percent chance of a cut by Christmas, compared to 85 percent on Wednesday.
Currently, markets only assign a 10 per cent chance of a rate cut at next week’s RBA meeting.
