The most anticipated central bank decision will be taken this Wednesday. The first interest rate cut in the US in this decade is expected. What markets should investors focus on? What else to look for from the Fed? We outline it in this analysis:
- The FOMC bound to cut by 25 basis points
- Prospects for more easing key to market reaction
- Gold, US500, BUND10Y among winners from policy easing
The decision: 25 cut and what next?
The Fed will announce its decision at 8pm CEST (7pm BST) on Wednesday. It will be accompanied with a statement and followed by conference 30 minutes later. Investors are nearly sure that a 25 bps cut will be delivered. Chances for a bigger (50 bps) cut are marginal amid some decent US data (latest NFP and GDP) while a refusal to cut would be met with a massive market and political disappointment – something the Fed will want to avoid. Because the cut is expected, market reaction will depend on outlook for future policy moves and this can be clarified during the conference. Will President Powell describe the cut as a one-off action or will he open the door to more easing? The markets hope the latter will be the case. If so, pay attention to those 3 markets.
Precious metals like gold, silver or platinum are obvious winners of expansive monetary policy. Lower interest rates make many safe alternatives to gold (especially cash) less attractive. What is more, Fed encourages other central banks to act as well and many investors see precious metals as a place to hide from “paper money”. Gold price has risen 6% since the last FOMC meeting and the market is somewhat overbought technically but with interest rate cuts any pullbacks should be short-lived.
Two past easing cycles helped drive gold prices substantially higher. Source: xStation5
The Fed is a big reason why the US stocks are close to all-time high. US500 has gained over 3% since the last FOMC meeting despite global economic weakness. Not all indices did so well. But can the Fed policy alone propel the markets higher and higher? A lot will depend on the economy. In the 90’s the S&P500 surged from 20% (1995) to 35% (1998) within a year from the first cut as the economy held up well but in 2001 and 2007 it tumbled by more than 20% (with more to come) as the cut did not prevent the economy from entering recession.
Lower interest rates are seen as positive for stocks, unless… they herald a recession as it was the case in 2001 and 2007. Source: XTB Research
The Fed move has benefited… German 10-year bonds! How is that possible? Policy easing from the Fed paves the way for other central banks to push the easing button as well. The ECB will be in this group and since it already has negative interest rates, investors bet that the Bank will also reintroduce asset purchases.
A signal of more expansive policy from the Fed has helped expand a massive rally on BUND10Y. Source: xStation5