09/23/2024

A global cycle of interest rate cuts cannot be announced without the participation of the Federal Reserve, which is fundamentally the driving force behind these decisions. It has been over a year since some central banks, including major ones such as the European Central Bank and the Bank of England, began easing monetary policy. But last Wednesday, the world's most influential central bank stepped in and changed everything dramatically.

Although the move was announced in advance, the 50 basis point cut was by no means predictable, and its significance can hardly be overstated given the Fed's crucial role in global dollar liquidity conditions. In fact, prior to the meeting, neither the Fed members' announcements nor the published macroeconomic data had led experts to expect such a significant cut. In fact, it is quite unusual for the Federal Reserve to initiate a cycle with a 50 basis point cut without the threat of a financial crisis or job losses.

Therefore, this move likely underscores the Fed's determination to prevent a deterioration in labor market conditions while inflation returns to the 2% target, or in the words of the market, to achieve a soft landing. Chairman Powell described the 50 basis point cut as a recalibration aimed at putting policy on a more neutral course, as the risks to inflation and employment are currently seen as balanced.
Indeed, the significant rise in the unemployment rate is likely to have added to the urgency of this recalibration. In the six months ending in August, the unemployment rate in the US had risen by 0.4 percentage points, a sharper increase than most other central banks faced when they initially cut their rates. The Fed has updated its statement to emphasize its strong commitment to supporting full employment.

Regarding the pace of rate cuts in the coming months, the Fed indicated that rate cuts of this magnitude are not to be expected in the future. Instead, rate cuts of 25 basis points will be the norm, with two more in 2024 and four in 2025, reflecting a fairly gradual pace of easing.

The Fed's interest rate cut will have a direct impact on monetary policy in emerging markets. For instance, the Bank of Indonesia already surprised the market last week with a rate cut of 25 basis points. The People's Bank of China also used the Fed's move on Monday to cut its 14-day repo rate slightly. A similar adjustment to the one-year lending rate, which will be announced on Wednesday, could also be on the cards. Overall, the Fed's cut will allow central banks in emerging markets to cut their own rates further.

Ultimately, the Fed succeeded in convincing the market that such an aggressive rate cut was not driven by fear of an imminent sharp economic slowdown, but rather by a desire to decisively initiate the easing process in a risk environment that is no longer dominated by inflation. The market's reaction was delayed but significant. Expectations of a soft economic landing were reinforced, and share prices rose sharply worldwide.

What can we expect going forward? In the short term, we face significant political risks, with the presidential election in the US, which is just over a month away, being the most prominent. Geopolitics will also play a major role due to the escalating conflict in the Middle East and the direct confrontation between Israel and Hezbollah. Lastly, incoming macroeconomic data, which is inherently volatile, could cause investor anxiety.

However, as long as there are no factors that change the soft landing narrative, markets are likely to recover from any signs of weakness, as we witnessed in August and September. In short, the Fed's decision marks the beginning of a period that has historically benefited financial asset prices, both fixed income and equities