While a 50 bps Fed rate cut was not out of the ordinary, the important fact is that the Fed is trying to sound dovish and saying this move is only a recalibration to preserve the currently strong labour market from downside risks.
Adrian Mowat: The Fed seems to be doing its job and I am not sure how important it is to focus on the fact that they have cut 50 bps rather than 25 bps. We have got a balance of risk here between the labour market and inflation and the Fed needs to move to neutral interest rates. Powell was being tested through many questions during the press conference about what neutral interest rates are and when you look at the dots, there is a diverse opinion within the board of the Federal Reserve.
Let’s say the neutral rate is 3% or maybe a little bit below that. But that is an interesting one for the bond market because the bond market got ahead of itself with yields falling sharply and the inversion of the yield curve is a record high with maybe one exception during the Volcker years. And so, this is an interesting one for markets, because it removes volatility from the interest rate markets since it looks like yields on 10-year are too low and they probably need to correct a bit and that will have some disruptive effect on the equity market.
We have seen a very matured reaction from US equities which climbed nearly 1% after the FOMC statement and settled in a little bit soft. DXY slipped briefly to about 100, and ended near about 101. The 10-year yield jumped up about six basis points. What are we staring at from an equity market reaction? Is the Fed indicating that there’s more in store before the year ends? Would it raise red flags to bloated markets across the globe that the US economy has a problem?
Adrian Mowat: I do not think it is fair to say that the US economy has a problem. As the Fed was mentioning, the labour market data is less robust than it was. But, I would hardly call it soft. If you look at some of the regional Fed’s data, they have got relatively high forecasts for GDP growth for this quarter. So, it is wrong to take this view that, gosh, we have got a 50-point cut, and should now start to panic about the economy.
I would look at another way that the Fed had interest rates at a high level. This allows them to have a fair amount of firepower to cut those interest rates to signal that they are going to support growth and provide that confidence and that is important. As we go into 2025 and the Fed is moderating interest rates, inflation continues to come down.
So, the impact on real income moderates from inflation. It looks for an outcome into 2025 of this not even a soft landing, the economy is still growing. It is a favourable outcome and the issue for the equity markets is going to be around economic growth because the markets are reasonably well priced and we need that earnings growth to continue. The earnings growth at a broad level requires economic activity to be good. I would take the view that one can be modestly optimistic about economic activity in the United States going into 2025 and would still be favourable to owning equity risk.