How US Fed rate cut affects global equity markets and commodities–experts weigh in
Marc Giannoni, Chief US Economist at Barclays and Arvind Sanger, Managing Partner of Geosphere Capital Management, discuss key takeaways from the US Federal Reserve’s 50 basis point rate cut on September 18, in an interview with CNBC-TV18.
This is the verbatim transcript of the interview:
Q: The market reaction yesterday, maybe is what flummoxed some people, or maybe the commentary and, of course, what led to it is US Fed Chair Jerome Powell saying that 50 bps is not the new pace, and kind of painting a rosier picture of the economy. In that sense rate cuts, which are kneaded by weak data, are bad news, but you don’t have that weak data, and you get a 50 bps cut, it’s kind of the best of both worlds. Would you be inclined to view it that way? What is your sense?
Giannoni: Absolutely. I think the overall economy in the US is still doing well, growth is still very solid, and gross domestic product (GDP) growth in Q2 was 3%; in Q3 we expect north of 2% in real terms. So solid growth here, still supported by consumers. So, then the question is why is the Fed cutting?
The Fed is cutting because it sees that inflationary pressures have come down, they feel confident that inflation is turning and returning sustainably towards the 2% target and at the same time, the labour market, which is the other side of their mandate, seems to be at full employment, but is easing, is cooling. The labour market is cooling, and they want to make sure that they keep it near full employment where it is, and not that it gets into more weakness.
Also Read: US Fed slashes rates by 50 bps — Jerome Powell’s top quotes on economic outlook
So, what we saw today is on the part of the Fed, an effort to recalibrate their policy stance by bringing down the funds rate to a level that is more consistent with the easier labour market conditions and also the lower inflation and make sure that they do not endanger the labour side of their mandate.
Q: What is your sense? Ultimately, the question is, what does it mean for markets from here, can it provide fresh impetus to global markets? India, of course, being a league of its own, clear outlier in that sense. But all said and done for the lack of a better phrase, it is a happy cut. It is not a sad cut.
Sanger: It is an interesting way to put it – a happy cut. I cannot disagree. The reality is that 5.5% is a tight condition for where the long-term neutral rate may be. The long-term neutral rate may be 3-3.5-4%, as the Fed sees it right now. And 5.5% is clearly tighter conditions and with inflation rapidly diminishing and maybe closer to 2.5%, not quite 2% but at the same time unemployment rising, the risk of staying too tight too long is the risk that we could tip the economy over into recession.
Right now, the economy is not looking that week, but it could weaken if the financial conditions remain tight, well past the neutral rate. So that is why the Fed may be admitting that they might be a little behind the curve, and they should have done 25 bps in July and 25 bps now. They did not explicitly say that, but that is implied by this 50-bps cut in one shot to make sure that the financial conditions get towards neutral much faster. And that helps global liquidity, markets and risk capital.
Q: That begets the question, what happens to emerging markets? The US cuts rates by 50 bps with 50 bps slated for this year as well. So where do you see emerging markets headed as a result of this and on that, India? It has already run up. People are talking about valuations at one extreme here. Do you see this as an incremental positive for India, or an incremental positive for emerging markets, ex-India?
Sanger: If I were to answer this, I would say that if you look at the US market today, the best-performing part of the market was the Russell 2000 which is the value part of the index, not the growth part of NASDAQ. India is like the NASDAQ. Other emerging markets may be more like the Russell, with more value parts.
So, on a relative basis, the value out of favour may benefit at the margin more than the momentum part of the market, which is India. But it does not mean that money will not flow into India or to emerging markets in general. So, India will benefit. But some of the laggard markets may be the bigger winners if financial conditions ease rapidly, as the Fed futures are indicating.
Q: Let’s talk about other asset classes as well. What does this rate-cut cycle mean for commodities that tie into what we can expect on inflation next? And also throw in a word on the other major central bank. Tomorrow, we are all watching out for the Bank of Japan, and the expectation is that at least tomorrow, they will not do anything, but a section of the market still believes that if they need to hike, they will, irrespective of what the Fed is doing. Would you agree?
Giannoni: Yes, I mean, for the US there was a lot of uncertainty about whether they would do 25 bps, or 50 bps cut. People, over the past week, have moved around that these expectations are quite a bit. But overall, the path for the funds rate is clear. The direction is downward. The question was 75 bps by the end of this year, and 100 bps by the end of this year. Now it looks like it is going to be 100 bps at the end of this year, with another 25-bps cut in November and another 25-bps cut in December as based on the Summary of Economic Projections (SEP).
Also Read: US Federal Reserve cuts interest rates by 50 basis points, another 50 likely by December
But broadly speaking, this is not changing the market expectations. So, whatever the commodities were pricing in and the other central banks were pricing in, has not radically changed by this new policy decision today, irrespectively of all the uncertainty that we have seen over the past week. It is pretty clear that the Fed is going to be cutting more, it has made very clear today that it is not going to cut rates at a very rapid pace, it is no longer going to do 50 bps. It is more like in the 25-bps range unless we see a very substantial deterioration in the labour market.
And so, in that respect, they project an economy that remains quite resilient, continues to grow solidly, that is going to be favourable for overall global economic conditions and supporting the world economy as a whole, as well as commodities as a whole.
Q: If this continues to be a gentle rate cut cycle then the market will love that. But finish the other point on the BoJ as well. Do you expect the BoJ to continue hiking and if that happens, I mean, I do not know what precedent we do have where one major central bank is cutting and the other is hiking.
Giannoni: They still have a large discrepancy in terms of levels and there are different stages of the cycle. The Bank of Japan is also dealing with inflation in a different cycle than the US. So, as part of where they are going, they may converge eventually, but for the time being, they may well proceed in different in different directions.
Watch the interview in the accompanying video
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