I covered the trifecta of central bank decisions in an article sent to subscribers yesterday and have included it towards the bottom of this update. These monetary policy decisions, especially that of the Fed on Wednesday, were the key drivers of investor sentiment last week. Investors reacted to the FOMC decision on Wednesday afternoon (50bps reduction in the Fed Funds rate) with a risk-on session across the world on Thursday, only to see a fade on Friday. Bonds were also volatile throughout the week, with yields on intermediate and long-maturity bonds moving higher. The culprits included:
Future expectations regarding monetary policy easing: There is a divergence between investor expectations regarding the trajectory of future Fed rate cuts vis-à-vis investors’ expectations, a topic I covered in the update on central bank decisions.
Mixed economic data / signals: There are mixed economic signals in the US economy. On one hand, data like first time jobless claims came in better (i.e. lower) than expected. On the other hand, bellwether #FederalExpress (#FDX) – arguably a leading indicator of the US economy – stumbled with its latest earnings report, which it blamed on customers downgrading to lower-cost shipping alternatives as its customer base faces margin pressures.
In the UK, the economic news was not inspiring. Although August retail sales came in above expectations as Brits had out their wallets, consumer confidence just hit its lowest level since 2022 according to GfK, while uncertainty abounds as the Labour government faces an immediate budget crisis, paving an unpopular but increasingly likely path forward including a combination of taxes increases and expenditure reductions in the October budget.
MARKETS LAST WEEK
The confluence of data caused yields on Treasury bonds to spike on Friday, although bonds were under pressure much of the week. The pain was felt across the curve, perhaps slightly more severe at the longer end of the curve as investors came to the reality that – again – the mantra of “higher for longer” might best characterise the expected reduction in the Federal Funds rate (compared to investors’ expectations). The spike in yields on Friday sent European and US equities into a funk as they gave back some of the gains from the day before.
European equities were slightly weaker WoW,
US equities were all better on the week, with the small cap (and more interest rate sensitive) Russell 2000 delivering the best performance (+2.1% WoW),
US Treasury bonds sold off at the intermediate and longer end of the maturity curve, with total return bond indices chalking up losses for the week,
Corporate credit was stronger (through Thursday), shaking off volatility in the equity and Treasury bond markets as investors – anticipating the end of days of 5%+ returns on short-term risk-free investments – seek returns by taking more credit risk,
The US Dollar was slightly weaker after itss rate decision, while the Yen came off its recent highs and was down 2.1% WoW,
Gold continues to reach record highs, and oil was better bid, too, as uncertainty rachets back up in the Middle East. Bitcoin was up 4.3% WoW, a strong performance as risk assets moved again to centre stage.
The tables below capture the performance of the indices and asset classes traced by EMC, updated for end of week.
CENTRAL BANK DECISIONS LAST WEEK
The Fed
I had thought leading up to the #FOMC rate decision that we would see a 25bps reduction in the Fed Funds rate, until the betting markets (mainly futures) shifted into a 25bps/50bps split at even odds. The shift in expectations a few days before the FOMC meeting was enough to convince me that the Fed had its army of governors and other spokesmen out paving the way for the possibility of a 50bps reduction, making a jumbo decrease more likely. And a 50bps reduction is exactly what we got. Whether it was 25bps or 50bps should not have really mattered that much, but it certainly dominated the news flow until the rate decision. And ultimately, it did matter to risk investors.For those of you that were not closely monitoring markets around the time of the FOMC decision on Wednesday afternoon, US stocks twisted and turned in the last two hours of trading, but ultimately ended up slightly down. I have marked the peaks and troughs of the S&P 500 index in the last two hours of Wednesday’s trading, and the Thursday opening.
The gyrations Wednesday afternoon were not so much because of the size of the rate cut, but rather changing expectations during Mr Powell’s press conference around the trajectory of future reductions in the Fed Funds rate.
The Fed Chair was of course cautious as usual, but his comments made sense. The infamous dot plot from the revised Summary of Economic Projections, released concurrently with the FOMC rate decision, is illustrated to the right. As the dot plot illustrates, FOMC decision-makers seem to be expecting further Fed Fund rate reductions of 50bps the remainder of this year (year-end Fed Funds range of 4.25% to 4.50%), 100bps more in 2025 (year-end range of 3.25% to 3.50%), and 50bps further in 2026 (year-end range of 2.75% to 3.00%). The terminal rate for Fed Funds would appear to be the level at the end of 2026. It is of course impossible to know if these projections will come to pass. But what is clear is that investors are expecting a steeper rate decent. For example, the CME FedWatch Tool is suggesting 75bps of decreases the remainder of 2024 – 25bps at the November FOMC meeting (two days after the US Presidential election) and 50bps at the December FOMC meeting. Perhaps more importantly as we head towards the new year, investors seem to believe we will end 2025 with a Fed Funds rate of 2.75% to 3.00%, 50bps lower than the Fed’s projections (and at the implied terminal rate). These sorts of expectations could set risk markets up for potential disappointment if investors are overly optimistic regarding rate reductions (even though implicitly this means they are more bearish on US economic growth).
In any event, risk investors absorbed all the information and ultimately cheered the rate decision in the U.S. as the inevitable party in risk markets started, extending around the world, beginning in Asia Thursday morning and ending in the US Thursday afternoon. What’s not to like as equity markets soared to new record highs? The rally attracted risk takers in other markets, too, with Bitcoin soaring nearly 5% so far this week.What does this FOMC decision really mean? Not as much as markets are suggesting, at least not to me, because ultimately it will be is a combination of the speed of monetary policy easing, the economic drivers behind the easing, and the terminal rate for the Fed Funds rate that matter much more. The Fed remains clear that future decisions will remain data dependent, meaning the state of the U.S. economy – and specifically the US jobs market – will continue to be key drivers going forward.
The Bank of England
As if it mattered following the FOMC decision on Wednesday, there was also a Bank of England monetary policy decision on Thursday. Before the meeting, UK CPI for August was released and was in line with expectations, setting the stage for the Bank of England to do nothing at Thursday’s Monetary Policy meeting as had been expected (summary of and minutes from the BoE meeting here). Mr Bailey set the stage for a further 25bps reduction in the Bank Rate at the next Monetary Policy meeting in early November. The combination of the BoE sitting tight and the Fed serving up a jumbo reduction sent Sterling to its highest level since February 2022 ($1.3315/£1.00). UK equities weakened following the release mid-day on Thursday, and are opening lower again this morning.
Bank of Japan
Similar to the Bank of England, the Bank of Japan left its monetary policy on hold, although investors are expecting further tightening this year. Even though August CPI came in slightly above expectations, the BoJ is navigating a narrow corridor in which it is trying to gradually normalise (i.e. tighten) its monetary policy without spooking markets again (like in early August). The Yen has strengthened slowly and more orderly recently, and this seems to have taken some pressure off the BoJ and allowed them to deliver what investors were expecting – nothing. Investors in Japanese equities liked the decision, spurred first by the Fed’s jumbo reduction and then by the continuation of the BoJ’s monetary policy decision announced this morning, with Japanese stocks finishing 3.7% higher in the last two trading sessions of the week. The Yen no surprisingly did lose ground following the decision, now at ¥143.65/$1.00.
Summary: central bank decisions
The drama this week was around the size of the reduction in the Fed Funds rate, but otherwise, the trifecta of central banks served up what was expected even though Japan is going one direction, and all the other central banks are going another. The surprise rate reduction by the Fed did spur risk markets globally. Drilling down slightly deeper in the US, the rally in stocks was more pronounced in the tech sector and small caps, the latter more sensitive to changes in borrowing costs. In effect, the broadening of the equity market rally seemed to pause, with large cap blue chip defensive stocks going nowhere fast while tech shares and small cap stocks – those most sensitive to interest rate changes – rallied hard. US Treasury yields also backed up following the decision across the curve, more pronounced at intermediate and longer maturities.
WHAT’S AHEAD
Economic data this coming week includes:
Preliminary manufacturing and services PMI data for September for the US, the Eurozone and the UK;
Select housing data in the US,
Consumer confidence in the US and Eurozone;
CPI for Japan for September; and
PCE data in the US for September, the Fed’s preferred inflation gauge
Monetary policy meetings:
FOMC (Fed): Nov 6/7 and Dec 17/18
Bank of Japan: Oct 30/31 and Dec 18/19
Bank of England: Nov 7 and Dec 19
ECB: Oct 17 and Dec 12
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