Yesterday, the FED delivered its first rate cut in five years, opting for a 50-basis point reduction. This move, likely influenced by the need to boost consumer confidence ahead of the upcoming November elections, was larger than anticipated, signaling that the central bank may have been behind the curve. Let’s explore the details of this meeting and its implications going forward.
The FED now sees the risks to its dual mandate — inflation and employment — as balanced, and I tend to agree with this assessment. Inflation has eased over the last six months, with a forecast of 2.3% PCE by the end of 2024 and 2.1% for 2025. However, inflation expectations remain higher, and much will depend on U.S. fiscal policy following the elections. Unemployment is rising, with a forecast of 4.4%, but this increase has been slow, and employment data has been inconsistent.
The FED is confident that it can navigate resilient growth and the labor market through this policy recalibration. Growth appears to be the key driver, perhaps even more than the rates themselves. They also indicated that Quantitative Tightening (QT) will continue, though I believe we will likely see a pause in H1 2025. The dot plot anticipates two more cuts this year and four in 2025, targeting a 3.4% rate. The U.S. two-year yield has already priced in this path, which seems reasonable.
Following the ECB’s recent decisions (they've already cut rates twice by 25bp), the FED has chosen to frontload its easing trajectory. Getting the rate below 4% appears to be a straightforward decision. However, what happens in mid-2025 will depend more on broader policy decisions and geopolitical developments rather than projections of FED officials. One significant impact of reducing monetary tightness will be a minor reprieve in interest expenses for the Treasury, although the effects will not be felt for another two years. As a foreign holder of U.S. debt, facing the unsustainable path of the large twin deficits, real rates below 1% will likely be a sell.
Looking ahead, I expect risky assets to perform well following this dovish stance through the year’s end, partially mitigating the uncertainty around the U.S. elections. There will likely be a preference for high yield and higher beta equities overcrowded, quality names. Historical statistics on equity performance after the start of a rate-cutting cycle are mixed, but much will hinge on the level of economic activity. I remain in the camp of a mild slowdown rather than a full recession. If consumer spending holds up, as it has thus far, we could see the profit cycle continue to support markets.
Alexandros Tavlaridis
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