Please see the below update from Evelyn Partners, received this afternoon – 19/09/2024.
September Bank of England MPC decision
What happened?
Coming hot on the heels of Federal Reserve’s sizeable 50 basis point cut overnight, the Bank of England (BoE) held their base rate at 5.00% at their meeting today. This was consistent with market expectations (57/58 economists surveyed by Bloomberg) following the first 25 basis points (bps) cut this easing cycle in August.
The vote was split 8-1 with Swati Dhingra, the anticipated sole dissident, expressing a preference to ease another 25bps to 4.75%.
What does it mean?
While developed market central banks have begun a coordinated cutting cycle, volatility in rate expectations in the US over the past week stands in contrast to the ‘steady as she goes’ developments in the UK. This highlights differences in the health and dynamics of Western economies, as well as the mandates of the banks themselves.
Recent data in the UK reflected an unattractive combination of weaker than expected GDP growth and sticky inflation – with core CPI at 3.6% and services at 5.6%. A new line in the policy statement said, “in the absence of material developments, a gradual approach to removing policy restraint remains appropriate” and was taken by the market as relatively hawkish.
Bottom Line
The BoE held interest rates at 5.00%. As per their previous rhetoric, we expected them to continue to emphasise their data dependence meeting-by-meeting but acknowledge and flag that markets are pricing a 25bps cut in for their next November meeting.
September Federal Open Market Committee policy decision
What happened?
The Federal Open Market Committee voted to cut rates by 50bps to 5.0% (upper bound) at the conclusion of their meeting yesterday. There was little doubt that the Fed would cut rates, but whether they would go for a ‘regular’ size 25bps or the ‘large’ 50bps was the subject of much speculation. The decision to make the larger cut was not unanimous, with one member casting a dissenting vote in favour of the smaller cut, the first time this has happened since 2005. This cut marks the end of keeping rates on hold, which lasted 8 consecutive meetings since the last increase in July 2023.
What does it mean?
The Fed’s move is larger than many forecasters had anticipated – 62% of the 1400 market professionals surveyed today by Deutsche Bank thought that the Fed would only cut by 25bps. This contradicting the futures market which adjusted this week to suggest the larger cut was more likely, following articles in the financial press suggesting the decision was closer than markets were then anticipating.
Fed chair Jay Powell said in the news conference today that the “US economy is in a good place and our decision today is designed to keep it there”. The statement revealed some concern over the labour market, changing language around job gains from ‘moderated’ to ‘slowed’, alongside repetition of their recognition that unemployment was creeping up although remained low.
The risks to the larger cut are that there is less pressure on inflation to move back towards the 2% target – the most recent datapoint for PCE, the Fed’s preferred measure was 2.5% on an annualised basis. Yesterday’s statement said that the ‘Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals continue to move into better are roughly in balance’
Despite this larger initial move, messaging from the Fed did little to move the likely path of interest rates according to the futures market, which expects rates to fall to around 2.9% by the end of 2025. This still stand below the Feds newly published DOTS plot estimate of 3.4% by the same point. The plot also revealed an expectation for lower rates thereafter, reducing from just above 3% to just below 3% by the end of 2026. Powell said in the conference that rates are not on a “preset” path, and that the pace of cuts could change with the inflation and jobs market data.
Although yesterday’s larger move was not fully anticipated by the futures markets, there was little sign of panic in prices following the announcement. The yield on two-year government bonds (a proxy for the direction of monetary policy) fell 10bps on the announcement but regained its prior level later. US Equities were volatile, gaining initially before falling back to the end the session slightly lower.
Bottom Line
The Fed made a larger start than many expected to their first easing cycle since the pandemic. The effect of monetary policy on the real economy is subject to long and variable lags which are hard to know in advance and change from one cycle to the next. We still think the ‘soft landing’ is the most likely outcome for the US economy and expect the rate cutting cycle will continue to aid a rotation in the equity market, away from the dominant mega-cap stocks who will earn less on their cash piles and towards recently unloved areas of the market such as small caps who will benefit from cheaper borrowing costs on their floating rate financing.
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Charlotte Clarke
19/09/2024