The much-anticipated US interest rate cut finally arrived this week. While the cut was a certainty with markets, investors were on the fence about whether the US Fed would reduce rates by 0.25% or 0.5%. In an almost unanimous decision, 11 out of 12 Fed members voted for a 0.5% interest rate cut. The expectation is that we will see a further 1.5% in interest rate cuts by the summer of 2025.
If we think back to the beginning of the year, the expectation was that we would see seven rate cuts for the year and the first cut would occur in the March meeting. It was then pushed back to the May meeting and now in September we have seen the first US rate cut in four years. US Fed Chair Powell and his committee have kept a close eye on data points such as inflation and the labour market as they try to achieve “restoring price stability without the painful increase in unemployment”. The level of the cut was largely debated with many prominent investment banks expecting only a 0.25% reduction. It’s unlikely that the US Fed will continue to cut rates by 0.5% at each meeting going forward. The next Fed meeting will take place the day after the US election begins on the 5th of November, so it may be likely we see a pause at that meeting as the election takes centre stage.
US equity markets initially rallied on the drop-in interest rates, but eventually closed marginally down on Wednesday. However, after a big move up yesterday, the S&P500 hit its 39th all-time high of the year and the technology heavy Nasdaq index is up over 2% for the week.
As we mentioned the US Fed had various data points to evaluate in the run up to Wednesday’s meeting with retail sales for the month of August (month-on-month) rising 0.1% despite market expectations of a -0.3% fall. Online retail and sporting goods were able to offset the weakness in restaurants and bars where spending was flat. Gas station spending fell 1.2% but that was largely driven by weakness in oil prices.
The Bank of England (BoE) also met this week but before the meeting UK inflation for August was announced and came in unchanged at 2.2%. The BoE have often made it clear that they want to see services inflation fall towards target as that has remained extremely sticky and it was concerning to see services inflation tick up to 5.6% last month. There was also a rare 22.2% rise in airline tickets which is the second largest rise since 2001. Following the data, Sterling rose above $1.33 as investors began to trim bets on the BoE cutting rates the following day.
Market expectations were correct as eight out of nine policymakers for the BoE voted to keep rates unchanged. It was an easy guess that policymaker Swati Dhingra would hold the contrarian view and vote to cut rates by 25bps. Governor Bailey spoke following the meeting, maintaining a cautious tone that the BoE needed to see more evidence of price pressures cooling. The news led to further strength in Sterling, which is now at levels not seen in over two years. It’s almost two years since Liz Truss’ infamous budget, at which point Sterling approached parity with the USD.
A central bank that is marching to the beat of its own drum is the Brazilian central bank. Inflation in Brazil fell to 4.2%, however the bank’s monetary policy committee, named Copam, were concerned by larger than expected economic growth which rose to 3.3% over Q2 24, as well as concerns around rising wages. This fear of a potential resurgence in inflation led to a unanimous vote by policymakers to raise interest rates by 25bps to 10.75%. Markets worry this may not be the end of their hiking spree and expect two further 25bps increases by year end leaving the interest rate at 11.25%.
On Friday morning there was mixed data from the UK. Retail sales came in better than expected, rising 1%. However, public sector net borrowing was higher for the month of August, and this will cause concern for the new Chancellor, Rachel Reeves, ahead of her October budget. Consumer confidence has fallen recently with some suggesting the concerns around a difficult budget are beginning to negatively impact the consumer.
A jumbo rate cut from the US was enough to support equity markets this week. As we have commented on before, the prospect of lower inflation and interest rates, coupled with moderate global growth could be a supportive backdrop for risk assets. The ongoing question is whether policy rates have been held too high for too long, which could lead to an economic slowdown. As such we continue to tread a careful path of both attack and defence in portfolios.
Nathan Amaning, Investment Analyst
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.