Markets Brush Off Fed Rate Cut as the Outlook Remains Uncertain
The past week saw markets absorb a significant 50 basis point interest rate cut from the US Federal Reserve, yet by the end of the week little changed as uncertainty remains high about the economic outlook.
The Fed's larger-than-expected rate cut on Wednesday initially boosted sentiment, with equities hitting new record highs and the US dollar falling. However, a mixed bag of economic data and diverging Fed commentary caused optimism to fizzle out by week's end.
On the positive side, Fed Chair Jerome Powell exuded confidence that the US economy remains in a good place and the rate cut was not made out of recession fears, but because inflation has fallen faster than expected. The Fed's dot plot now projects rates ending 2024 at 4.375%, implying just two more 25bp cuts this year, compared to market pricing for two more 50bp cuts this year.
However, Fed Governor Michelle Bowman dissented from the decision, worried that inflation could reignite if rates fall too far too fast with the labour market still tight. Meanwhile, consumer confidence posted its largest drop since August 2021 on rising job worries, though this contrasts with still upbeat University of Michigan sentiment. Amongst the economic forecasting community debate over the likelihood of a recession has re-emerged with 40% of analysts now seeing a US recession in the next 12 months.
Internationally, the Bank of England held rates steady at 5% and signalled gradual cuts ahead as UK inflation remains sticky. Strong UK retail sales affirmed the BoE's patient approach. The Bank of Japan also remained on hold, with Governor Uwayeda seeing no rush to tighten further, causing the yen to slump 2% for the week.
Optimism around China helped underpin risk sentiment, after the People's Bank of China, (PBOC) announced a significant stimulus package aimed at the property sector and hinted that fiscal measures may be pulled forward. This fueled gains in Chinese equities and the yuan.
In Australia, a strong jobs report and the Reserve Bank of Australia holding rates at 4.5% pushed back on market expectations for rate cuts in 2024. RBA Governor Lowe emphasised rates would stay higher for longer to ensure a sustained return of inflation to target.
Emerging Markets were the top performers, gaining around 6% over the week. Japan also posted strong gains of approximately 4%. The S&P 500, European Equities and Global Small Caps all rose by about 2%. The UK and European markets lagged these gains but still ended the week higher. Australia's market performance was in line with the S&P 500 and Global Small Caps.
While PBOC measures were the main driver of outperformance of Emerging Markets, Japan and Europe’s buoyancy may suggest that investors are becoming slightly more optimistic about the global growth outlook, particularly in economies that are leveraged to a rebound in trade and manufacturing.
10-year government bond yields in the US and Australia both rose slightly over the course of the week suggesting that, despite the Fed's rate cut, markets are pricing in a shallower easing cycle than previously expected. The steepening yield curve suggests bond investors also believe the economic slowdown will be mild enough for inflation to remain contained, allowing central banks to take a gradual approach to cutting rates.
Gold surged around 3.5% to hit a new record high as falling interest rates and a weaker US dollar boosted the appeal of the non-yielding precious metal as a safe haven. The broad-based gains in both risk assets and gold suggest markets are balancing optimism around a soft landing with caution over the potential for economic headwinds to persist. We suspect many investors are seeking to participate in a growth rebound while also maintaining some defensive positioning which could be supportive of cyclicals which are probably priced for a recession at this point.
Overall, the week reflected the high degree of uncertainty in the outlook as central banks weigh resilient economies and labour markets against falling yet still-elevated inflation. While the Fed has pivoted to easing, for now it seems set for a shallower path than markets expect. Much will hinge on upcoming inflation and jobs data to gauge the likely course ahead.
