Quick view: ​Mid-cycle adjustment - one in a row



Paul O'Connor, Head of the UK based Multi-Asset Team, examines the market's response to the Fed's first rate cut in over 10 years.

As expected, the US Federal Reserve (Fed) cut interest rates for the first time in over 10 years. Given that the 25bps reduction appeared to be fully priced into markets before the meeting, the Fed’s communication about future moves was always going to be the key driver of the market response. Fed Chairman Powell’s messaging in the press conference was complicated. He did not deliver the dovish clarity that many were hoping for and equity markets sold off as consensus interest rate expectations edged higher.  

Once again, a Fed meeting ended with many commentators criticising Powell's monetary policy communications skills. However, it seems only fair to highlight that he has a difficult job on his hands right now given the unfamiliarity of the current global economic landscape and the conflicting trends at play in the world economy.

From a historical perspective, it is unusual to see the Fed cutting interest rates when the US economy is growing steadily with the unemployment rate close to a 50-year low. Still, the Chairman justified his actions by focusing on muted inflationary pressures and uncertainties overshadowing the global economy such as Brexit and China-US trade - that was all pretty much as expected. However, the mood in the press conference and the market response soured when he referred to the cut as being “a mid-cycle adjustment” and not necessarily “the beginning of a lengthy cutting cycle”.    

With inflationary pressures still subdued globally and many of the drags on global growth looking set to persist, there is a good chance that the Fed will cut rates again in 2019. The key question for markets is whether future Fed actions will validate the prevailing consensus expectation of another three to four cuts in the year ahead. The dovish Fed trade is now highly consensual and fairly aggressively priced in. This can also be seen in mutual fund/ETF flows this year, which have seen US$268bn into fixed income and US$254bn into money market funds.

With this monetary milestone now passed, attention will now return to the conventional business of scrutinising economic data for evidence on the health of the US cyclical recovery. Friday’s payroll data will be the next point of focus. Still, translating signals from US macro data into interest rates projections will be no easy task, given the complex political cross-currents buffeting the global economy and the uncertainty surrounding the impact of macro fluctuations on the Fed’s interest rate decisions.

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