The Federal Reserve is set to cut interest rates on Wednesday for the first time since the onset of the Covid-19 pandemic – and despite widespread predictions that the move will be hit, global investors are bracing for the fallout.
The Fed supports many of its central bank peers, including the euro area, UK, Canada, MexicoSwitzerland and Sweden, these countries have already cut interest rates.
Many policymakers have stressed their willingness to stay ahead of the Fed, often seen as a global leader, in responding to slowing domestic economic growth and easing inflationary pressures.
However, some analysts question how far they can go before the Fed – the world’s largest central bank by assets – follows suit, given the ripple effects of its actions.
global influence
A major concern is the pressure that interest rate differentials are putting on the currency.
Generally speaking, higher interest rates attract more foreign investors looking for higher returns, pushing up the value of the local currency.
This has been seen in the current Japanese cycle JPY and turkish lira They get hit hard when their central banks keep interest rates low, and Dollar The yuan’s exchange rate (as measured against a basket of currencies) soared throughout 2022 as the Federal Reserve tightened its grip on interest rate hikes.
These differences are particularly difficult for central banks trying to control rising prices, as a weaker currency can lead to inflation by making imported goods more expensive.
In addition to foreign exchange, another important impact of the Fed’s rate setting is the impact on the U.S. economy, especially given the recent focus on labor market weakness and the possibility of recession.
“As an important driver of global economic growth, this is bound to have an impact on global asset prices,” Richard Carter, head of fixed-rate research at Quilter Cheviot, said of the Fed rate cut.
This includes gold – The index hit a record high this week on expectations of action by the Federal Reserve. Higher interest rates are widely believed to be a drag on gold because they make fixed-income investments such as bonds more attractive, although this has not always been the case historically. Gold is also used as a hedge against inflation (which can push higher as interest rates fall), and investors also buy the commodity during times of market stress.
Oil Other commodities, typically priced in dollars, tend to get a boost from interest rate cuts, as lower borrowing costs stimulate the economy and increase demand.
Many emerging markets are more sensitive to these factors, making the Fed’s actions more important to them than to larger economies. Stocks are also affected by the Fed’s moves – and not just in the U.S.
Much of the volatility in global stock markets in recent months has been linked to speculation about when and how much the Federal Reserve would cut interest rates.
Quilter Cheviot’s Richard Carter continued via email: “Rate cuts lower dollar borrowing costs, creating easier liquidity conditions for companies around the world.”
“Falling U.S. interest rates would also lower yields on U.S. assets such as U.S. Treasuries, making other markets relatively more attractive,” he added.
Cut deepest first?
Although the market is confident that the Federal Reserve will start its interest rate cutting cycle on Wednesday, there is considerable uncertainty over the remaining three meetings this year and the extent and speed of interest rate cuts in 2025.
Among them is whether the first rate cut will lower the federal funds rate by 25 basis points or 50 basis points, taking it below the current range of 525 to 550. Last week, commodity markets priced According to CME Group’s FedWatch tool, “huge” rate cuts have jumped from less than 50% to nearly 70%.
“Regardless of the outcome, the market will move,” Steven Bell, chief economist at Columbia Threadneedle, said in a note Monday.
“It is unusual for the Fed to subject markets to such a level of speculation ahead of a meeting, especially so close to the U.S. presidential election. I can only speculate that the committee itself is divided,” Bell continued.
November’s election has raised questions about the direction of U.S. fiscal policy and how that will affect inflation and monetary policy.
Joe Tuckey, head of foreign exchange analysis at Argentex, said that historically, the Fed’s initial 50 basis point rate cuts “have been preceded by some poor stock market returns,” particularly in the run-up to the 2007 financial crisis and in the 2000s. Early days. The tech bubble market collapsed.
“Essentially, the need for deeper rate cuts signals concerns about growth and economic troubles ahead,” Taki said.
However, Hani Redha, multi-asset portfolio manager at PineBridge Investments, said it was “more important” to consider pricing cuts of more than 270 basis points towards the end of 2025.
Redhar said “economic data is still not enough to give the market direction,” and he backed defensive sectors.
“I think the initial reaction will be mixed, but stocks are likely to remain firm until there is a more decisive breakthrough in economic data.”
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