Executive summary:
- The U.S. Federal Reserve kicked off the easing cycle with a jumbo-sized 50-bps rate cut
- The Bank of England left interest rates unchanged, citing elevated services inflation
- U.S. equities soared in the wake of the Fed's rate decision
On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, discussed the latest rate decisions from the U.S. Federal Reserve (Fed) and the Bank of England (BoE) as well as the market reaction.
Fed lowers borrowing costs by 50 bps
Kshatriya opened by assessing the Fed’s Sept. 18 decision to lower its benchmark lending rate by 50 basis points (bps) rather than a more traditional 25-bps rate cut. “This was slightly out of character for the Fed, which ending up dropping rates by more than many analysts expected,” he stated, noting that market pricing on the size of the cut fluctuated right up until the central bank’s announcement. Ultimately, however, the Fed delivered a cut in the direction the market was leaning, Kshatriya said, lowering its policy rate to a range of 4.75%-5.0%.
He explained that with the Fed’s conviction that inflation will continue to decelerate toward its 2% target, the central bank’s focus has shifted toward protecting the U.S. labor market. “Monthly jobs growth has downshifted, and the U.S. unemployment rate has increased sufficiently to trigger the "Sahm Rule" recession indicator. While this increase is due to immigration boosting the supply of labor rather than layoffs—the typical factor that triggers this indicator—it's a trend the Fed feels it needs to stay ahead of,” Kshatriya stated.
Source: LSEG DataStream, Russell Investments. *Longer run projection based on the Federal Reserve Summary of Economic Projections as of September 18, 2024. The chart shows the upper end of the Fed funds target rate.
That said, he noted that the tone of the latest macro data has been positive. For example, U.S. weekly initial jobless claims fell by 12,000 in the week ending Sept. 14—the lowest level since May, Kshatriya remarked. “This is an indication that layoffs are not picking up—a sign that was corroborated by Chair Jerome Powell at the ensuing press conference, where he mentioned that Fed officials aren’t hearing concerns about a layoff cycle from business leaders,” he stated. In addition, other recently released data like retail sales and industrial production also came in healthy the week of Sept. 16, Kshatriya said, noting that the Atlanta Fed’s GDPNow model is currently projecting GDP (gross domestic product) growth of around 3% in the third quarter.
So, what could this mean for future rate cuts? Kshatriya said he expects the Fed to lower rates at a 25-bps pace at the remaining meetings this year and into 2025. This would take the policy rate to around 3.0%-3.25% in about a year—the mid-point of the Fed’s estimate of where longer run rates will be.
He added that another 50-bps move cannot be ruled out at the Fed’s next meeting in November, noting that the health of the U.S. labor market will likely factor into the central bank’s decision. By the time of the Nov. 6-7 meeting, the Fed will have seen employment reports from both September and October, Kshatriya said, giving central bank officials plenty of data points to help inform their decision.
Bank of England keeps rates unchanged after initial August cut
Turning to the UK, Kshatriya noted that the BoE went in a different direction than the Fed the week of Sept. 16, with BoE officials opting to forgo a rate cut at their Sept. 19 meeting after lowering rates the prior month.
He said that a hotter-than-expected core CPI (consumer price index) reading in August helped keep the BoE on hold, noting that the core CPI rose from 3.3% in July to 3.6% in August. In addition, the August CPI report showed that inflation in the services sector remains elevated at a level of 5.6%, Kshatriya noted.
However, he said that BoE Governor Andrew Bailey remarked after the meeting that the bank is prepared to loosen policy “gradually” if economic conditions evolve as expected. “Markets are interpreting these remarks as a sign that the bank will lower rates at its next meeting, with current pricing indicating a roughly 75% probability of another 25-bps cut in November,” Kshatriya said.
S&P 500 sets new record high following Fed announcement
Kshatriya wrapped up with a look at how markets reacted to the Fed’s 50-bps cut. He said that the U.S. 10-year Treasury yield, which initially fell when the decision was announced, bounced back as markets digested the central bank’s summary of economic projections and Powell’s comments. “The rise in the 10-year yield since the conclusion of the Fed meeting likely reflects the Fed's non-committal guidance and good macro data,” Kshatriya remarked.
He said that the more interesting reaction has been in the equity space, where the benchmark S&P 500 Index set another record high on Sept. 19, closing above 5,700 for the first time. “The larger Fed cut strengthens the likelihood that the U.S. economy will be able to achieve a soft landing, which is supportive for equities,” Kshatriya stated, noting that such an outcome remains Russell Investments’ central scenario. In addition, corporate earnings have been solid and tech names have rebounded, both of which have also supported the march higher in markets, he concluded.