The easing cycle commences

The Federal Reserve has cut its main policy rate – the Fed funds rate – by 0.5 percentage points, taking the targeted range to 4.75-5%. This is the first time the Fed has cut US interest rates since the early days of the pandemic in March 2020.

The response from markets has generally been positive – despite our earlier apprehensions. Brief choppiness yesterday evening has given way to a strong rally this morning: European and US equity market futures are firmly in the green today. Elsewhere, the US curve is steepening again, the dollar is little changed, and gold is edging higher.

While the timing of the first US interest rate cut should come as little surprise, we’ve been in two minds about the size of the Fed’s first move. In opting for an aggressive first cut, the Fed appears to be pre-emptively easing before growth starts to more visibly cool (or even reverse). Whether they can fine-tune – or ’recalibrate’ – policy that carefully remains to be seen. In any event, we’re not there yet: growth is tracking at above-trend pace – and inflation is not yet sustainably back to target. A point that is echoed by the Fed’s relatively benign economic projections.

To Powell’s credit – and the first Federal Open Market Committee (FOMC) dissenter since 2005 – he was eager to temper enthusiasm for big rate cuts ahead. The Fed dot plot – which charts FOMC members’ rate expectations ahead – has shifted in a more dovish direction since June, but it still signals a relatively gradual easing cycle. The median dot points to a further 0.5 percentage points worth of rate cuts this year (over two meetings), followed by a further 1 percentage point next year (over eight meetings) – which is less aggressive than the 2 percentage points discounted by money markets.

At the risk of stating the obvious, it’s clear that this latest move will not be a case of ‘one and done’. But whatever lies ahead, we still feel that the direction of travel matters more than the magnitude – at least as far as risk assets are concerned. The mix of disinflation with growth has meant that 2024 has so far been supportive for capital markets – as we’d thought it could be. Adding falling interest rates (and stabilising corporate profitability) to that favourable mix suggests there is perhaps still further stock market headroom ahead.