Aura Global Insights – Issue No. 20
US RATE CUT: AN INDECISIVE FED?
As generally expected, the US Federal Reserve (Fed) decided to cut the official funds rate overnight. The more important question for markets was the magnitude of the policy easing and the communication of the decision. The Fed eased by 25 basis points in-line with consensus. However, the policy decision was described as an insurance cut against downside risks or weakness in global growth and trade, rather than the start of a substantial easing cycle. In addition, the Fed’s intention was to create a “somewhat more accommodative stance” that is a “mid-cycle adjustment” which has clearly disappointed some market participants who might have hoped for greater policy easing.
The good news was that the Fed also decided to end its balance sheet adjustment a couple of months early - a modestly dovish signal.
How price responded to the decision was more like the Fed hiked rates. Of course, the starting point in price terms for US equities was just below the record high. Nevertheless, by not providing a more dovish signal, the Fed has effectively tightened broad financial conditions. That is, the US dollar strengthened, equities have declined over 1% at the time of writing and credit spreads have widened. In the US bond market, 2 year yields increased and the 10 year yield declined.
Bottom Line: If financial conditions tighten further over the coming months, it is plausible that the Fed will be compelled to ease again. Clearly today’s decision may challenge some of the more aggressive pricing in fixed income and bond proxy assets. Looking further out beyond the impulsive short-term reaction, equities, remain challenged by the profits outlook. The correlated belief in low rates has also clearly been a key (the only) factor driving valuation multiple expansion and returns this year. Based on the Fed’s posture, we would not be surprised if volatility increases over the coming few quarters.
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