This evening, the US Federal Reserve (Fed) has lowered its benchmark interest rate by 50bps to 4.75-5% target range, with 10/19 officials in favour of cutting.
It’s the first time in four years that the Fed has cut rates – and they’ve gone beyond the usual 0.25% straight for 0.5%. This US Federal Reserve’s latest interest rate decision, will be largely welcomed by the markets although with the next decision due on 7th November, just after THAT Presidential Election, further cuts and the prospect of a soft landing will be much debated. But what does it really mean? For markets, for the economy and for UK policy makers due to announce their next interest rate decision tomorrow?
Investment strategists and economists have been sharing their reaction to this significant news of a big US interest rate cut as follows:
Powell had his “whatever it takes” moment says Carlo Putti, Investment Director at M&G Investments as he comments: “About 10 years ago, Mario Draghi, the then-new president of the ECB, famously said that he was ready to do “whatever it takes” to restore stability in the Eurozone. That three-word statement was a decisive and influential moment during the Eurozone crisis, signalling the ECB’s unwavering commitment to preserving the euro and restoring market confidence.
Fast forward to today, and Powell had his “whatever it takes” moment by starting the cutting cycle with a bang: the FOMC decided to cut rates by 50 basis points instead of the 25 bp expected by many economists. Powell made it very clear that the Fed is now focused on the labour market and will do whatever it takes to support it.
The Fed realized they were behind the curve, particularly when it comes to the labour market, and decided to play catch-up by cutting more than expected and partially making up for the delay in starting the cutting cycle. This doesn’t mean they will continue to cut very aggressively. Powell did say that 50 bp should not be considered the new norm and that a series of 25 bp cuts is what we should realistically expect. However, he wanted to ensure that people understand the Fed is ready to act—and act aggressively—if the labour market were to deteriorate faster than expected.
Draghi’s whatever it takes moment proved to be very successful, will Powell achieve the same result?
If there is something we have learned over the last few years, it is that the U.S. economy is much less sensitive to changes in interest rates than many thought. If a sharp increase in interest rates didn’t hurt the economy that much, how do you think cutting rates by 50 bp will stimulate it? Fed officials remain comfortable that adjusting interest rates will enable them to achieve stable nominal growth and a strong labour market. I hold my doubts about the effectiveness of interest rates today and believe we might end up in a situation where the Fed will have to act much more aggressively than many currently anticipate.
This is an interesting macroeconomic environment, and we need to remain open-minded and accept that things won’t necessarily play out the way we were taught in school.”
Also sharing her reaction, Lindsay James, investment strategist at Quilter Investors said: “The Federal Reserve has fired the starting gun with a supersized 0.50% cut to interest rates, putting an end to its more than a year long run of holding rates steady at 5.25-5.5%. Investors had only begun to attribute a meaningful probability to a half point cut in the past week. Disappointing labour market data was published on the eve of the Fed’s blackout period, leaving it potentially unable to use forward guidance to its usual extent. This meant the meeting held an unusually high level of uncertainty for investors. However, with inflation falling further in subsequent data, officials will have weighed the risks of reigniting inflation against the evident cooling of the jobs market and clearly felt the scales tipped in favour of a larger cut.
“Today’s announcement also comes with an update to the Fed’s dot plot – the chart which shows where voting members of the Fed expect rates to be at the end of each of the next few calendar years. In its previous update in June, members appeared to be expecting an average of just one cut by the end of 2024. Now, there seems to have been a shift in expectations as at least a further one, if not two cuts are anticipated before year end. However, though the Fed has made a bold move in kicking things off with a 0.50% cut, it is perhaps more likely that we would see a 0.25% cut at its November monetary policy meeting as the Fed will still be reluctant to move too much too soon.
“Markets appear to have been a bit overzealous when it comes to pricing in how hard and fast the Fed will go with rate cuts, with rates expected to have fallen to around 3% in a year’s time. The latest dot plot has shifted significantly lower for 2025, but it is still above the level implied by market pricing. Though the market has already priced in the full potential for rate cuts in the year ahead, there is a risk that this may not materialise if inflation were to spike again. The US economy looks likely to avoid a recession at present, but we know all too well how quickly things can change so some caution is still warranted.
“The ECB opted to cut rates last week, and the Fed has followed suit. However, the Bank of England looks set to break the trend tomorrow, particularly following inflation figures this morning which showed headline inflation remained stagnant at 2.2% while core inflation rose.”
Garry White, Chief Investment Commentator at Charles Stanley comments: “The Federal Reserve has given markets what they have desired for some time – the sugar rush of a significant cut in borrowing costs. They will cheer what this means for valuations in equity markets, but a 50-basis-point cut looks too extreme.
“There’s nothing in recent economic data to suggest a severe deterioration in the US economy is imminent. A cut of this magnitude could have a sting in its tail. It risks fanning the flames of suggestions that something is amiss in the world largest economy and recession fears could re-emerge. Yet, nothing much has really changed. Expectations for a soft landing for the US economy remain intact.
“After becoming accustomed to cheap money and extremely accommodative central banks to deal with the banking crash and Covid-19 pandemic, markets need reminding that things are different now – and policy is going to normalise. The size of this cut risks blunting this important message too.”
Toby Gibb, Head of Investment Solutions at Artemis, responding to this evening’s announcement by the Fed of a rate cut said: “Fed Chair Powell’s comment at Jackson Hole last month that ‘the time has come for policy to adjust’ left market participants in little doubt that we would see a cut at this month’s meeting – the first in more than four years. However there has been an unusual level of uncertainty about whether the central bank would cut by 25 or 50bps.
“The market had been moving to price a 50bps move over the last few days and the Fed has delivered. This isn’t the first time that the Fed has started a rate cutting cycle with a bigger move. In 2001 and 2007 they also began with a 50bp cut. Recessions followed within months, which doesn’t bode well for the Fed. The latest 50bp cut was in March 2020 during the pandemic, followed by a 100bp cut just 12 days later. This will fuel concerns that the dovish 50bp cut today means the Fed is more worried about the state of the economy than recent employment and retail sales data would suggest.”
Isabel Albarran, Investment Officer at Close Brothers Asset Management, sees this cut as a clear signal from the Fed but stresses that eyes will now be on the market’s reaction as she comments: “Today’s bumper 50 basis point cut marks a pivotal moment for the Fed, representing their first cut in over four years and bringing an end to weeks of debate about how aggressively they would act. While the scale of this cut is by no means a surprise, it sends a clear signal that FOMC members are serious about protecting the economy from recession. That said, this bumper cut is also an acknowledgement of the weakening in the labour market data and accusations that the FOMC has been slow to respond. The question now is how markets interpret today’s move – it seems likely that more easing still will be priced in.
“While further cuts are definitely on the table into 2025, the scale and speed of these will largely depend on how the economic picture evolves. With inflation now pretty much under control, edging closer and closer to the central bank’s target, FOMC members have made it clear that further weakness in the labour market is unwelcome. This will no doubt be the focus of their attention over the coming months, and the key factor dictating their decisions in Q4 and beyond.”
Hetal Mehta, Head of Economic Research at St. James’s Place, says: “The Fed has surprised most economists but placated markets by cutting by 50bps. They say risks are balanced but this will be seen as dovish.
“The aggressive rate cuts markets are pricing – over 200bps in less than a year – seem unwarranted to us.
“Something that risks getting lost in the 50bps excitement is that the longer run rate has been nudged up once again.
“A re-balancing of the labour market, especially with increased labour market supply, does not signal imminent recession. That said, inflation is in a comfortable enough range to allow some cuts and a policy normalisation towards neutral rates should be enough to foster the much-coveted soft-landing.”
