That was it. The US Federal Reserve reduced interest rates by 0.5%. What was strange was that there was no obvious reason for doing so. A cut of 0.25% would have been just fine. This would have been a nod to lower inflation, but also acknowledged that their economy is doing OK. For example, according to the Atlanta Federal Reserve the US economy is growing well above trend.
Cutting by 0.5% would have been prudent if there was a risk of an imminent recession – there isn’t. By cutting more than necessary now, they also reduce the scope to cut more sharply when a recession does loom up, or some crisis requires emergency rate cuts e.g. pandemic.
In the hours after the announcement on Wednesday there was extreme volatility in the US stock market, US government bonds and gold. They all finished lower, suggesting some doubts as to the rationale. But by Thursday most markets were in a forgiving mood, with new highs for US equities and gold. It is the subdued reaction of the US Treasury market which persisted, because that market relies on reason and numbers, and risks were seen which by-passed exuberant stock market investors.
With the US economy chugging along nicely, and their stock market at all-time highs, the risk is that the Fed is stoking what were meant to be the dying embers of the inflationary pyre. More confident investors and consumers are inflationary.
Hints of inflation reviving in the months ahead will quickly push yields in long dated government bonds higher, with the risk that the downturn in prices from 2020-2023, (in excess of 50%) will resume. This would certainly hurt equities, and might also make gold investors pause for thought in the short term.
Did the Fed read the economic runes in a way which escaped the attention of most others? If they did, they didn’t say so. Or are they concerned about a Chinese downturn which will destabilise the world economy? Ditto. Or did they have a vision of Trump being in the White House instead of the Glass House, so decided to give Kamala’s odds of election a boost? Ditto.
Of course if inflation is buoyed, and kept at higher levels than markets expect for years to come, this is great news for the (unsustainable?) mountain of US government debt, as the value will slowly but surely shrink. That is most definitely not part of the Fed mandate – but it would be very convenient if it came to pass.
Despite those doubts and unanswered questions, the bumper rate cut was good news for Asia, and potentially very good news for China, as it now creates a window for them to cut rates too.
This has been reflected in the winners over the last week. FTSE China 50 and the Hang Seng are both up 5%, that is “A” shares as well as “H” shares, where domestic investors in “A” shares have been particularly noticeable by their absence for some months. It is far from clear that the Chinese equity markets might at last have hit bottom, as a cut in their interest rates is mere window dressing when more fundamental government action is needed. One to keep an eye on in coming weeks.
Japan and the tech-focused Nasdaq rose by a less eye-watering 2.1%-2.4%. Of major indices, only Brazil and India had minor losses. The UK trod water, with some gloom ahead of the Autumn Budget on Wednesday 30th October.
Gold was only up 1.3%, but gold miners were up in excess of 6%. Where central banks drove the price of the former up in Autumn 2022, the gold miners only started moving from March 2024, as retail investors slowly began to join the party. The sort of growth differential experienced over the last week reflects not just the greater potential of the gold miners vs gold, but also the considerably greater volatility. That being so, those of you who are more fleet of foot might apply “stop-profits” with gold miners when you enjoy sharp profits over short periods.
Predictably the US dollar fell over the week, with lower rates making it less attractive. We set out opportunities arising from a weaker dollar in the 23rd August note.
In that same note I referred to some basic analysis projecting a possible peak just ahead of 5744 in the S&P 500. The highest intra-day price was 5733 yesterday, and the closing price was just 0.5% below that projection. Interesting times.