Markets rise as the Fed joins in the rate cutting

Key takeaways

Initial reaction to an outsized US interest rate cut was muted, but markets rallied as investor risk appetite improved.

The Fed begins cutting interest rates…
Excepting its emergency cuts during COVID-19 pandemic, the 0.5% reduction in interest rates by the US Federal Reserve (Fed) to the 4.75%-5.00% range was its largest cut since 2008’s global financial crisis. Fed chair Jerome Powell commented that the size of the central bank's cut was a “recalibration” in response to the large decline in inflation since 2023. The move has been interpreted by some as a trade-off between the Fed’s mandate to reduce inflation to its 2% target as much as possible, but without risking higher unemployment. Fed policymakers are projecting a further 0.5% reduction by the end of the year, 1% in 2025 and 0.5% in 2026.

…while the Bank of England remains cautious
A further rate cut so soon after August’s 0.25% reduction from a 16-year high was considered unlikely by most investors. The Bank’s governor indicated his concerns – that wage growth looked set to remain elevated, while a debate lingered about the speed with which longer-term inflation was coming down. In particular, the August services inflation component figure of 5.6% year-on-year was high. Despite the UK’s current 2.2% annual headline rate of inflation only marginally above its 2% target, the Bank thinks this could accelerate to 2.5% by the end of the year. Investors have scaled back expectations that the Bank will cut rates twice more before the end of this year.

Why attention has shifted to the labour market
The Fed’s attention is now shifting from inflation reduction to the state of the US labour market, which is defined as those who are employed plus those who are unemployed. The unemployed are those not working, and available in addition to looking for work. The unemployment rate is those unemployed as a percentage of the labour force, and has risen from a low of 3.4% to 4.2% in the US. Unemployment can rise either because people lose their jobs, or a rise in the number of available workers. Worryingly, more than half of the change in the higher unemployment rate since the final quarter of 2023 can be explained by job losses, not by a higher supply of available workers.

Market moves

• Following the Bank of England’s decision to hold interest rates at 5%, the pound rallied to $1.33, its highest level for 30 months.

• The gold price hit another record high of $2,622/oz, a year-to-date gain of 27%.

• Mercedes-Benz issued its second profit warning in less than two months, affected by weak markets in China and Europe, and the sluggish sales of electric vehicles.

What to look out for this week

• The German Ifo Business Climate Index (a highly regarded indicator of the business environment) for August will be released on Tuesday, and is expected to show a slight decline month-on-month.

• On Thursday, the latest Personal Consumption Expenditures (PCE) Price Index, which is the Fed’s preferred inflation measure, is forecast to rise by only 0.1% in August compared with July.

• On the same day, Fed Chair Jerome Powell will speak at the US Treasury Market conference.

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