News of the week summary - 09/22/2024
Federal Reserve cuts rates by half a percent
The US Federal Reserve has initiated its first interest rate cut since the pandemic, reducing the benchmark rate by 0.5%, bringing it to a range of 4.75% to 5%. This marks a significant shift after over a year of keeping rates at their highest levels since 2001 to combat inflation.
The decision reflects the FED’s growing concern over potential economic and labor market weakening. The size of the cut—larger than the usual 0.25%—is a proactive move aimed at sustaining economic growth. FED Chair Jay Powell emphasized that the US economy remains strong, and the rate cut is intended to maintain that strength while controlling inflation.
Several factors motivated the FED’s decision:
- Inflation control: After peaking at 7% in 2022, inflation has eased, with the Personal Consumption Expenditures (PCE) price index down to 2.5%, closer to the FED’s 2% target.
- Labor market concerns: Job growth has slowed, and the FED wants to avoid further weakening. The unemployment rate is projected to peak at 4.4%, slightly higher than current levels.
- Economic outlook: While inflation is stabilizing, signs of a softening labor market, like slowing demand and vacancies, suggest the economy might need support.
The decision wasn’t unanimous. Some FED officials preferred a smaller cut or no cut at all, but most policymakers forecast further reductions. By year-end, rates could fall to 4.25% to 4.5%, signaling potential additional cuts in the coming months.
In the longer term, the central bank projects the federal funds rate could decline to around 3% by 2026. However, Powell stressed flexibility, indicating that future moves will depend on economic data, especially inflation and employment trends.
Financial markets reacted swiftly to the announcement. US stocks initially rallied, while European and Japanese equities rose the next day. The yen weakened against the dollar as investors predicted the Bank of Japan would maintain its low-rate policy.
The rate cut is likely to reduce the appeal of low-risk money market funds, which have seen massive inflows since the FED began raising rates in 2022. As rates decline, investors may seek higher returns in equities or riskier assets. Analysts expect money market assets, currently at $6.3 trillion, to shift toward stocks and bonds as investors adjust to the new interest rate environment.
Gold reaches historic highs
Gold prices soared past the $2,600 per ounce mark for the first time, driven by expectations of further interest rate cuts in America and heightened geopolitical tensions, particularly in the Middle East. Spot gold climbed 1.3% to $2,620.63 per ounce, while US gold futures settled at $2,646.20.
The FED’s decision to cut interest rates by half a percentage point added momentum to gold’s appeal, because lower interest rates reduce the opportunity cost of holding gold, a non-yielding asset, making it more attractive to investors.
Ongoing conflicts in Gaza, Ukraine, and other regions have increased global uncertainty, further boosting demand for gold as a safe-haven asset.
A continued decline in the value of the U.S. dollar also has made gold cheaper for investors holding other currencies, adding additional support for the metal's price surge.
However, this price spike has dampened retail demand in major gold-consuming countries like China and India, where buyers have pulled back due to the high prices.
While some analysts believe the rally could continue due to geopolitical risks and ongoing monetary easing, others warn that the surge may not be sustainable. Marginal ETF inflows and reduced demand in Asia suggest the market could face a correction. Additionally, with the FED expected to proceed with smaller rate cuts in the near future, the conditions driving gold’s dramatic rise may weaken.
S&P 500 surges to all-time high
The S&P 500 (an index tracking the market capitalisation of the 500 most valuable companies traded in America) surged to a record high following the FED's decision to cut interest rates by half a percentage point, signaling a potential soft landing for the US economy. Wall Street’s benchmark index rose 1.9%, with the tech-heavy Nasdaq index gaining 2.8%. Lower interest rates typically boost high-growth sectors like technology, which led the rally, while defensive sectors such as consumer staples underperformed.
Global markets also experienced strong gains. In Europe, the Stoxx Europe 600 (tracking the 600 most valuable European companies) and Cac 40 (which tracks the 40 most valuable French companies) rose by 1.4% and 2.3%, respectively, while Japan’s Topix index (which tracks 100 Japanese companies) gained 2%. The dollar saw mixed movements against major currencies, and Bitcoin spiked 5.3%.
Emerging markets are also poised to benefit from the lower US rates, which reduce borrowing costs and enhance the appeal of non-US assets.
Bank of England holds rates at 5%
On Thursday, the Bank of England (BoE) voted 8-1 to maintain its key interest rate at 5.0%, emphasizing a cautious approach to any future rate cuts. This decision came as the BoE navigates the complex balance between curbing inflation and preventing excessive economic slowdown. There was only one member advocating for a 0.25% rate cut, following last month's first rate reduction since 2020.
BoE Governor Andrew Bailey stressed the need for caution in reducing rates, noting that inflation, particularly from wage growth, remains a concern. While Bailey expressed optimism that rates would eventually fall, he emphasized the importance of waiting for more evidence of cooling inflation.
The BoE announced a further £100 billion reduction in government bond holdings, continuing its program of quantitative tightening. This will lower the BoE's holdings to £558 billion by September 2025.
The bank now forecasts UK inflation at 2.5% by the end of 2024, down from a previous estimate of 2.75%, thanks in part to lower oil prices. However, wage growth remains elevated, contributing to long-term inflationary pressure.
Investors have scaled back expectations for aggressive rate cuts, now predicting that the BoE will cut rates in quarter-point steps over the next year. By contrast, the U.S. Federal Reserve is expected to implement a faster rate-cutting cycle.
The BoE's quantitative tightening brings losses due to the sale of gilts at lower prices, which are underwritten by the UK taxpayer. However, these fiscal implications did not influence the BoE's decision, according to Bailey.