Tuesday's Talking Points
Potential Cut in US Federal Funds Rate – An Event in the Making!
What’s the Point?
In the Federal Open Market Committee (FOMC) Meeting to be held on September 17 and 18, 2024, it is expected that the United States (US) Federal Reserve (Fed) may start cutting its Federal Funds Rate – with the rate cut being estimated to be either 25 basis points (bps) or 50 bps. Currently, the Chicago Mercantile Exchange Group is indicating a 65% probability of a 50 bps cut in interest rates. Nonetheless, a rate cut could be a significant step because the borrowing costs could witness a significant drop from its elevated levels for the first time in 4 years. Furthermore, as the US Consumer Price Inflation (CPI) has dropped below 3% and the growth in non-farm payroll has remained weak, the Fed wants to ensure a “soft landing” in order to keep economic growth on track without letting it slip into a recession.
Numbers in Perspective
Source: Bloomberg, US Bureau of Labor Statistics
Factors that are prompting the cut in Federal Funds Rate
- Inflation now under control
As the US CPI started reaching elevated levels due to a pickup in economic activity, the Fed gradually started increasing the interest rates from March 2022 to address the same, and completed the hiking cycle by July 2023.
Headline inflation has decreased from its elevated levels of 9.1% in June 2022. In August 2024, while the headline CPI, on a month-over-month basis, rose 0.19%, core CPI rose 0.28% – higher than the consensus expectation of 0.2%. On a year-over-year basis, this corresponded to 2.5% for headline CPI and 3.2% for core CPI (versus 2.9% and 3.2% prior, respectively). An upside surprise in core inflation of August 2024 played spoilt sport for the short-term momentum of disinflation from prior months, which had been mostly been consistent with the Fed's 2% target.
- Poor Labour Market Conditions
The US Bureau of Labour Statistics presents statistics from two monthly surveys – Household Survey (measures labour force status, including unemployment, by demographic characteristics) and Establishment Survey (measures nonfarm employment, hours, and earnings by industry). For August 2024:
- Household Survey: Both the unemployment rate, at 4.2%, and the number of unemployed people, at 7.1 million, changed little in August. These measures stood higher than a year earlier, when the jobless rate was 3.8%, and the number of unemployed people was 6.3 million.
- Establishment Survey: Total non-farm payroll employment increased by 142,000 over the month. Employment growth in August was in line with average job growth in recent months but was below the average monthly gain of 202,000 over the prior 12 months.
From Chart 2, we can infer that firms have slashed open positions, which has resulted in job openings rate to dip from its peak of 7.4% in March 2022 to 4.6% in July 2024. Currently, the ratio of job openings to unemployed people has returned to the pre-pandemic levels.
With decreasing job growth, marginally higher unemployment rate, and shrinking job openings rate, the US labour market has been tight. Hence, it would be interesting to see the impact of the expected rate cut on these metrics.
- Resilient Economic Growth despite Elevated Borrowing Levels
The US economy gained momentum in Q2-2024, with its Gross Domestic Product (GDP) expanding at an annualized rate of 3.0% – a notable improvement from the Q1-2024 growth rate of 1.4%. This growth has been driven by a solid increase in consumer spending, which has consistently been the biggest driver of the economic expansion. While the Fed has managed to allay any recessionary fears through timely interventions, continuing to spend at a sufficient pace to keep the economy growing can be challenging at elevated borrowing levels. Hence, a rate could potentially aid the economic growth.
What impact could the cut in interest rates have on US Equity, Debt and Commodity Markets?
As per US Bankcorp, for much of 2024, US large-cap stocks have outpaced mid-cap and small-cap stocks because of higher financing costs, as a result of elevated interest rates. This has disproportionately affected smaller companies that have had limited cash reserves and need to issue debt more frequently. The direction of equity markets is yet to be observed. Keeping that in mind, it would be noteworthy to witness the potential impact of interest rate cut on the equity markets.
Jerome Powell – Chair of the Federal Reserve – at the Jackson Hole Symposium on August 23, 2024, indicated that various economic parameters of US signal to the start of an interest rate cut. In anticipation of this event, US treasury yields have softened across the board – with the yields of US 1-year, 2-year and 10-year Treasury Securities decreasing by 49.4 bps, 31.5 bps and 23.4 bps respectively between August 23, 2024 and September 16, 2024.
Interest rates are key in driving the prices of precious metals. As a matter of fact, the movement of prices from the last interest rate hike of a given cycle, to 2 years after the Fed has made the last cut of the following easing cycle, indicates that prices of precious metals have increased over that period. While the timing of the start of cut in interest rates has remained uncertain, historically gold and silver have performed particularly well during easing cycles.
Sources: FOMC, Bloomberg, US Bureau of Labor Statistics, US Bankcorp, and other publicly available information
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