Weighty words, surprise rates
Jerome Powell’s announcement of a 0.5% cut in US key rates on 18 September successfully trod a fine line – startling the market and economists by the extent of the cut, whilst offering reassurance in his official press release and speech.
Surprise was inevitable. Bond markets remained undecided on the extent of the cut by the US Federal Reserve (Fed) right up until the last minute, with some anticipating the usual 0.25% cut and others a full 0.5% cut. There has not been such a major divergence between expectations and the actual announcement since 2009. Among Fed watchers – analysts who dissect each and every move of the US central bank – the surprise was even greater: only 7% were expecting this double cut.
However, the market’s reaction remained moderate, as illustrated by the fall in volatility in equities and bonds 24 hours after the announcement.
How did the Fed Chair achieve this delicate balancing act? The answer seems to lie in a tightly managed communication policy. Firstly, an official press release detailing the Fed’s view on the situation of the US economy right now, and its expectations for the medium and long term. The Fed indicated that it was worried by the fragility of the employment market, but confident regarding the direction of inflation. In parallel, the Board of Governors is expecting an unemployment rate of 4.4% at the end of the year, versus just 4.0% for the end of June. Furthermore, it anticipates that key rates will be 0.50% lower in December, i.e. there will be two successive cuts of 25 basis points in both November and December.
A successful manoeuvre from a market perspective. But a major error according to presidential hopeful Donald Trump, who considers these cuts an electoral gift to the party of the outgoing President and a sign that the “economy would be very bad”. Whatever he may think, this surprise move seems to further establish the Fed’s independence as it has completely disregarded the electoral timetable. Historically, wherever possible, the Fed has abstained from pronounced moves so close to an election.
What next? This accommodating shift has been long-awaited and postponed several times – now that it has actually started, it will loosen the stranglehold of interest rates on US consumers, who traditionally are very partial to consumer loans. It will also turn the attention of investors away from short-term investments, where returns will be automatically eroded. A “Fed put” is being reestablished – the central bank now has its hands free to cushion any sharp fall in the economy or markets, liberated from the yoke of inflation. Another reason to turn to riskier assets with potentially higher returns. Lastly, for companies, the fall in rates provides a breathing space for those with the highest debt levels, and lowers the cost of investments, which were previously unprofitable. This scenario is nonetheless based on the strong assumption that the employment market and therefore growth will hold up. If this is not the case, the Fed’s ability to maintain confidence will be seriously undermined.
Final version of 20 September 2024 Clément Inbona, Fund Manager, La Financière de l’Echiquier (LFDE)