Money rates fall, bond yields rise

In line with the ‘leaks’ conveyed by Nick Timiraos of the Wall Street Journal, the Federal Reserve has begun the cycle of interest rate cuts by reducing the Fed funds rate by half a percentage point to a range of between 4.75% and 5.0%. This choice is debatable, but not unreasonable in view of the probable fall in inflation, from 7% to 2.2%, observed since the summer of 2022 and the upturn in the unemployment rate, from 3.4% in April 2023 to 4.2% last month.

The decision was taken by a majority of 11 to 1, with Michelle Bowman in favour of a 0.25% cut. The projections unveiled last Wednesday and Jerome Powell’s remarks at the press conference suggest that the 0.5% cut should not be seen as an increment that will automatically apply at future meetings. The median of the forecasts unveiled last Wednesday now implies only two cuts of 0.25%, taking the Fed funds rate to between 4.25% and 4.5% at the end of the year, followed by a cumulative cut of 1% in 2025. These projections imply a more cautious path than is still expected by investors and traders. In short, the Federal Reserve has started its cycle with a strong move, but it is keeping a close eye on inflation and does not rule out interrupting its action if necessary.

In addition to the interest rate forecasts, the other projections reflect the hope and desire to achieve a ‘soft landing’, with real growth and inflation close to 2% in both 2024 and 2025, and unemployment peaking at 4.4% before falling back to 4.2%, which the FOMC now sees as a long-term equilibrium level.

The Fed’s generous rate cut does not sit well with recent indicators, which are generally positive. Although modest, the 0.1% rise in retail sales in August was good news after the 1.1% surge the previous month. The rebound in manufacturing output, which rose by 0.9% in August after falling by 0.7% in July, and the fall in initial jobless claims are symptoms that suggest that the US economy is continuing to expand at a robust pace that is hardly compatible with a rapid, large-scale cut in interest rates. This observation has not been overlooked by bond market participants, as evidenced by the fact that the yield on the US T-Note has risen by around ten basis points to around 3.75%.

In Europe, the Bank of England played it safe by keeping its key rate at 5%. The favourable trend in the UK economy, reflected in sustained growth in retail sales and positive signals from business surveys, validates the central bank’s gradual approach. These developments led to a slight increase in sterling yields, in line with dollar-denominated bonds.

On the euro capital market, yields are steady. The deterioration in the business climate highlighted by the latest surveys raises fears of a recession, which is already affecting the manufacturing sector. The decline in the services PMI from 52.9 in August to 50.6 in September could herald a recession and prompt the ECB to ease policy further on 17 October and 12 December. In Switzerland, the SNB is also set to cut its key interest rate to 1% on Thursday, while leaving open the possibility of a further reduction, in line with the Fed and the ECB.