Eonomists react to the news that the Fed cut interest rates yesterday.
The US Federal Reserve has cut interest rates by 0.25 per cent, or 25 basis points, to a target range of 2 per cent from 2.25 per cent. This is in spite of what is, as far as data seems to suggest, a strong economy without much slack in the system. Economists argue, however, that fears about an escalating trade war may require an “insurance”-style cut now and the markets appear to be pricing in further reductions.
The decision was not unanimous: Kansas City Fed chief Esther George and Boston Fed president Eric Rosengren dissented on the decision to cut rates, instead preferring an unchanged stance on interest rates.
Older investors may scratch their heads about how the world’s most powerful central bank thinks it is necessary to loosen monetary policy when – according to the Trump administration and official figures – the US economy is in such good shape. It is important to remember that when inflation (which is low) is factored in, real interest rates are barely positive. Over time, lousy returns on cash and cash-like investments hold down savings, and that’s bad for the kind of long-term investment that drives productivity growth and real wages. It has been argued that one of the reasons why wage growth has been sluggish in recent years is precisely because of low real savings rates in the US (and to some degree, other parts of the West). There is also the argument that the Fed has so massively expanded its balance sheet post-2008 that it has limited room to keep rates higher even if the economics warranted it.
Low interest rates also mean, as wealth managers know, that investors must go higher up the risk spectrum than they might otherwise like to get returns. It also explains some of the hunger for alternative investments, such as private capital, equity, forms of real estate, infrastructure, commodities, and precious metals. The environment has prompted investors to be willing to take the pain of less liquidity because they need the returns. Sooner or later, this equation is not going to add up any more.
With these thoughts out of the way, here are some reactions from wealth managers in Europe from yesterday’s cut by the Federal Reserve. We may update with reactions from US managers as they come in. To add your voice to the debate, email firstname.lastname@example.org
Looking forward, we expect the Fed to sanction two further cuts in the Federal funds target rate range, effectively to provide ‘insurance’ against downside risks and in response to muted inflation pressures. We see the next 25bps cut occurring in September, followed by a further reduction in Q1 2020, which should see the Federal funds rate bottom out at 1.50-1.75 per cent. Although [Federal Reserve] chair Jerome J Powell didn’t deliver any firm commitments on interest rate cuts, he will get another opportunity at the Kansas City Fed Economic Symposium, better known as Jackson Hole, on August 22-24, where he could provide updated guidance to markets.
The Fed’s decision was framed against an assessment of the economic outlook which was pretty much unchanged from the June meeting, in that the labor market was still assessed to be strong and that activity was seen rising at a moderate pace. Meanwhile inflation continued to be assessed as running below the Fed’s 2 per cent target. In light of the solid labor market and seemingly robust economy the rationale for last night’s cut came in the form of concerns around downside risks from the global backdrop (trade frictions) and muted inflation pressures. Indeed we very much view last night’s move as a precautionary cut given that the unemployment rate stands around a 50-year low and given our expectation that the US should see growth of 2.5 per cent this year.
Olivier Marciot, investment manager, Unigestion
After a period of patience and economic assessment earlier in the year, the Fed is now taking action. Tonight’s [Wednesday’s] decision is probably the first step in a sequence of adjustments in monetary policy, aimed at reviving economic expansion and bringing inflation closer to the bank’s 2 per cent target.
With this in mind, our current dynamic assessment articulates around three risk factors:
Macro risk: Growth conditions as indicated by our proprietary 'nowcasters', have stabilised around potential and show only minimal signs of improvement. The latest GDP print in the US is reassuring but remains the exception in the developed world. On the other hand, disinflation is still at work and remains the main source of concern for central bankers. This in turn will warrant larger accommodation for longer from central banks, until fundamentals materially firm. In the medium run, this dimension will remain supportive and benefit growth-oriented assets such as equities and credit.
Market Sentiment: Risk appetite remained solid through July, and should remain so now that the Fed has provided clarity on its future course of action. It would require a shock to reverse current optimism, such as a rapid surge in trade war tensions or a poor earnings season, for example. In the absence of a trigger, momentum should persist as positioning does not seem extreme yet and leaves room for another leg of positive returns. The picture is less clear on this front though, as expectations and market pricing were high going into today’s FOMC meeting.
Valuation: Most assets have become rich as a result of central bank action. Currently, hedging assets are more expensive than risky assets, which could trigger correlation distortions and limit their defensiveness. This favors relative value plays over long beta exposures.
Tim Drayson, head of economics at
Legal and General Investment Management
The Fed cut rates last night by 25bps, but the lack of forward guidance disappointed an aggressively priced market which has taken out 10bps of future cuts.
In the Fed’s Open Market Committee statement the description of the domestic economy remained the same, and forward guidance was slightly watered down as the committee stated its intent to continue monitoring incoming information rather than ‘closely’ monitor. There were two dissents in favor of no change: George and Rosengren. While both are regional Fed presidents, two dissents is unusual and suggests a split on the FOMC. However, nobody dissented in favour of a 50bps cut. The statement outlined that the Fed will conclude the reduction in its balance sheet two months earlier than previously indicated. It did not come as a surprise, as to continue shrinking the balance sheet would work at cross purposes to the rate cut (even though the balance sheet was originally supposed to be separate from active monetary policy decisions).
Gregory Perdon, co-CIO at Arbuthnot Latham,
the UK private bank
If Powell wants a good book deal, he should stand-up to the President and tell him that the last time he (Powell) checked, the Fed was in charge of monetary policy not the White House. The S&P is at an all-time high, unemployment is rock solid, little cracks in the housing façade and credit is largely okay (except some low grade). Why did they do it? It doesn’t seem sensible to me.
Whatever happened to the theory that we need fuel in the tank to support us during a real downturn? There is no evidence of a material slow down, so why is the Fed cutting? Let’s face it, the trade wars will end before the next Presidential election regardless of what deal Trump can secure - and when that happens, international trade will come roaring back and confidence will rocket – at that stage, the Fed will be forced to back track and shock the market. Do markets like reverses? Of course not.