Originally published at: This week in charts: Interest rate roundup – InvestEngine Insights
The jumbo Fed cut
We noted in our post last week that markets were heavily pricing in a 0.25% cut to the US Fed funds rate at their meeting this week. Since then, predictions for a larger 0.50% cut rose rapidly, to settle at a roughly 50/50 coin flip between a 0.25% and a 0.50% cut going into the Fed’s meeting.
The markets received their answer on Wednesday, which saw the Federal Reserve reducing its benchmark interest rate by 0.5%, and signalling further cuts ahead. This marks the first rate-cutting cycle since the pandemic began, and brings the federal funds rate to a range of 4.75% to 5%.
The significant half-point cut indicates the Fed is aiming to prevent any potential slowdown in the US economy and job market after keeping rates at their highest level since 2001 for over a year.
Market reaction on the day
US stocks rallied immediately after the announcement, rising 1.1% to reach a new all-time high, as investors welcomed the Fed’s effort to support economic growth amid easing inflation pressures.
It was to be short-lived, though, as Federal Reserve chair Jerome Powell dampened the market’s optimism at the press conference held after the announcement by stating: “I do not think that anyone should look at this and say, ‘Oh, this is the new pace.’” This tempered the market’s exuberance, which had rallied on the prospects of further sizeable rate cuts to come.
As the central bank tends to move in increments of 0.25%, a 0.50% rate cut is large by historical standards. Rate cuts of this size are usually employed to deal with economic disasters. The last time a 0.50% rate cut occurred was in response to COVID, before that it was a response to the 2008 crash, and before that the dot-com crash. This time, however, the market seems more sanguine about seeing a half-point cut. Powell mentioned that the Fed probably would have moved if they had had access to the surprisingly good inflation numbers for June, which were published shortly after their last meeting. The market therefore saw this cut more as a catchup to the missed cut in July, rather than in order to deal with any immediate economic concerns.
Given time to digest the announcement and accompanying comments, the S&P 500 closed at a record high the following day (Thursday) as investors bet the Federal Reserve’s jumbo half-point interest rate cut would help deliver a soft landing for the US economy. Lower interest rates are generally considered positive for stocks because they reduce companies’ debt burdens, encourage consumer spending, and nudge investors towards riskier assets.
UK inflation steady
Back in the UK, it was announced on Wednesday that inflation held steady at 2.2% in August — far below its 2022 peak of more than 11% and close to the BoE’s 2% target. The issue for the BoE, however, is with services inflation (inflation in things like hotels and restaurants), which remains high, and accelerated in August due to increases in demand for air travel.
Bank of England keeps rates on hold
After the inflation figures on Wednesday, Thursday saw the Bank of England holding interest rates at 5%, but indicated it may lower borrowing costs again as soon as November.
In a signal that another rate reduction is likely as soon as its next meeting in November, the BoE said that it would take a “gradual” approach to loosening policy, assuming there are no material changes in the economy.
This had little impact on what markets were pricing in, with the rate for the end of this still forecast to be around 4.5%.
The Bank of Japan follows suit with a hold
At their meeting at the start of August, the Bank of Japan surprised investors with a hike from 0.10% to 0.25%, which roiled global markets and caused the Nikkei to fall more than 10% in a single day, over fears of the global yen ‘carry trade’ unwinding. After causing such global market turbulence (the impact of which was thankfully short-lived), at their most recent meeting on Friday, the central bank took a more austere approach, holding rates steady at 0.25%. The bank pointed to a moderate recovery in the economy but warned that “high uncertainties” remain in the outlook for activity and prices.
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