Global stocks bet the positive news on Wednesday Sept 18th that the Federal Reserve’s jumbo half-point interest rate cut would help deliver a soft landing (no boom /no recession) for the world’s largest economy. The main US S&P 500 stock market index reached a record high. The technology focused NASDAQ stock market is only a few per cent away from the same milestone. European and Asian markets also rallied strongly .
Before Wednesday’s cut, US rates (5.25% – 5.5% – the Fed Funds rate is fixed in a 0.25% range) had been at their highest since 2001 part of the Federal Reserve ’s (US Central Bank’s bid) to bring down inflation from the biggest surge in a generation. But with consumer price inflation now at 2.5 per cent, close to the Fed’s 2 per cent target, the central bank has signalled more reductions to come.
Strategists at JPMorgan said comments by Fed chairperson Jay Powell and officials’ revised interest rate expectations reaffirmed a “Goldilocks narrative and should be viewed as positive for the economy and earnings”. (A Goldilocks scenario – like the fairy tale – means a result where economic growth is not too hot – causing inflation – and not too cold – causing recession).
In the latest “dot plot” of officials’ forecasts (the ‘”dot plot” is the average forecast by Federal Reserve officials on where they think US interest rates will be in the future), most expected the rate to fall another half-percentage point by the end of the year, to 4.25 per cent to 4.5 per cent. However, financial futures markets were pricing in that the Fed would make nearly three-quarters of a percentage point of cuts.
Foreign Exchange: The biggest driver of any currencies strength in the short term is the level of interest rates in that country. Given the Fed cut rates a bit more than expected this week the US Dollar weakened against other currencies. The Japanese Yen weakened 0.6 per cent to ¥143.14 against the dollar on Thursday. Traders expect the Bank of Japan to hold rates steady at a policy meeting concluding on Friday. UK Sterling was up 0.8 per cent against the dollar, climbing above $1.33, after the Bank of England held interest rates at 5 per cent on Thursday, but signalled it may cut rates again as soon November
Why do stock markets rise when interest rates are cut?
-because lower interest rates get the economy going leading to bigger corporate profits
-because the cost of corporate borrowing decreases leading to bigger corporate profits
-because bond yields /interest rates are lowered, this makes bonds less attractive investment than stocks
What are implications for banks when interest rates are lowered?
-It can be bad news, because when interest rates are high, banks can pay customers not so high interest rates on client deposits, but charge client borrowers the full high interest rate. When interest rates are lowered, the opportunity to do this is less leading to lower bank profits.
