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The first cut is the deepest

07 June 2024

Trustnet editor Jonathan Jones explores the impact rate cuts will have on markets.

By Jonathan Jones,

Editor, Trustnet

This week, the European Central Bank took the lead on monetary policy by becoming the first of the big three central banks to cut interest rates.

It was the first time in five years the ECB has cut rates, with the Bank of England (BoFE) expected to join its peer from the continent in the coming months.

The big question is what the Federal Reserve will do. After all, experts have warned that the BofE and ECB can’t go too much further without the Fed doing the same, or risk currency fluctuations that would be prohibitive to their inflation targets.

Next week, the US central bank will meet for the fourth time this year, but there aren’t many signs it is gearing up for a rate cut.

Most expect the result to be the same as the previous three meetings: no change in the headline Fed Funds interest rate of 5.50%.

The CME Fedwatch service has a 2% chance of a Fed surprise drop of interest rates, which feels pretty conclusive.

Russ Mould, AJ Bell investment director, said: “As such, the wait for the first, elusive reduction in headline borrowing costs continues, especially as financial markets began 2024 expecting six rate cuts from the Fed, down to 4% by the end of the year, with the first of those coming in March.”

This has been scaled right back, with markets now predicting just two cuts in 2024 down to 5%, with the first one coming in September. Yet, even this is far from given.

“The Fed has to acknowledge that unemployment is low at 3.9% and inflation, as measured by the consumer price index, is 3.4%, still some way above its 2% target,” Mould said.

“The Atlanta Fed’s Sticky-Price CPI index is up 4.4% year-on-year, to suggest the central bank has more work to do, especially as producer prices and the Fed’s own preferred measure, the Personal Consumption Expenditure index, are showing fresh signs of heating up, rather than cooling down.”

As such, most predict the Fed is a few months away from starting its rate cutting cycle – as is the Bank of England, which could hold off to move in lockstep with its US counterpart.

For investors, it means the discount rate applied to growth stocks will remain higher for a little while longer, but there is still a general trends lower.

In the coming months, the likes of the big tech names should start to face an easier time of it from a macroeconomic perspective – as if they needed the help.

Cash rates will start to drop, although rates are not expected to plummet, which should mean they remain relatively attractive, while bonds too could thrive as yields start to drop.

In all, it could be a strong period for investors, who will have a litany of options to choose from to make money. At least that’s the theory.

In practice, these things are never straightforward and other shocks could derail any sort of stabilisation from the macro picture. Solid research and decision making will remain key, even if it seems as though the future looks bright.

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