LONDON (Reuters) – When the Federal Reserve delivers a widely expected interest rate cut on Wednesday, the first in four years, the move will reverberate beyond the United States.
The size of a first move and the extent of overall easing remain open to debate, while the US election is another complicating factor for global investors and rate setters.
“We don’t know yet what kind of cycle this will be — whether it will be like the 1995 cut of just 75 bps or 2007-2008 of 500 bps,” said Kenneth Brooks, head of corporate research. , FX and rates at Societe Generale.
Here’s a look at what’s to focus on in global markets:
1/ Follow the leader
In the spring, as U.S. inflation proved stickier than expected, investors questioned how far other institutions, such as the European Central Bank or the Bank of Canada, could cut rates if the central bank were to hold off this year before their currencies weakened too much.
The United States is finally reducing initial facilities regions facing weaker economies than the United States.
As expectations of a central bank interest rate cut have increased recently, traders have been included in races for rate cuts by other central banks.
Although they are paying less for cuts in Europe than the central bank, the ECB and the Bank of England are more wary of remaining inflationary risks.
The prospect of Fed cuts starting is a boon for global bond markets, which often move in lockstep with Treasuries.
U.S., German and British government bonds are poised for first-quarter declines in late 2023 in anticipation of a Fed preemption.
2/ Breathing
Lower U.S. rates will give emerging market central banks more room to ease themselves and support domestic growth.
Half of a sample of 18 emerging markets tracked by Reuters have already started cutting rates this cycle, following the central bank’s lead, easing efforts to focus on Latin America and emerging Europe.
But volatility and uncertainty surrounding the US presidential election cloud the outlook.
“The US election will have an important impact on this because, depending on the various fiscal policies, it really complicates the cut cycle,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas. “In the wake of that we may see more idiosyncratic actions among central banks.”
3/ A strong dollar discount?
Those economies hoping that U.S. rate cuts will further weaken a strong dollar, boosting their currencies, may be disappointed.
JP Morgan notes that the dollar has strengthened after the first Fed tapering in three of the past four cycles.
The dollar outlook is often linked to US rates relative to others.
The safe-haven yen and Swiss franc are expected to nearly halve their respective discounts to U.S. rates by the end of 2025, according to Reuters polls.
Unless the dollar turns real low-yielding, it will continue to hold its appeal among non-US investors.
Meanwhile, in Asian economies, South Korea’s win saw the Thai baht and Malaysian ringgit rise through July and August, keeping U.S. cuts leading the markets. China’s yuan has erased year-to-date losses against the greenback.
4/ At the rally
A global equity rally that recently faltered on growth fears could resume if low U.S. rates lift economic activity and a recession is avoided.
Global stocks fell more than 6% in three days in early August following weak US jobs data.
“There is always a wobbly market around the first cut because the market wonders why central banks are cutting,” said Emmanuel Gao, head of European equity strategy at Barclays.
“If you have a cut without a recession, which is a mid-cycle script, usually the markets will go back up,” Gao said, adding that the bank prefers sectors that benefit from lower rates, such as real estate and utilities.
A US soft landing should also play well in Asia, although the Nikkei has fallen more than 10% from July’s record high and Japan’s rates are on the rise.
5/ Time to shine
Among commodities, precious and base metals such as copper should benefit from Fed rate cuts, and the demand outlook and soft landing for the latter are key.
Low rates and a weak dollar not only reduce the opportunity cost of holding the metals, but also spur momentum for those using other currencies to buy them.
“Higher rates are an important upside for base metals, with significant negative physical demand distortions from stockpiling and weighing on capital intensive final demand segments,” said MUFG’s Ehsan Koman.
Precious metals can also be obtained. Gold, which typically has a negative relationship with yields since most demand is for investment purposes, typically outperforms other metals during rate cuts. That’s a record high, but investors should be cautious, said John Reid of the World Gold Council.
“Speculators in Comex gold futures markets are positioned for this,” said market strategist Reid. “It could be buying the rumor and selling the truth.”
(Reporting by Karin Strohecker, Samuel Indig, Amanda Cooper and Eric Onstad in London, Yoruk Bahceli in Amsterdam and Tom Westbrook in Singapore; Graphics by Sumanta Sen, Tara Ranasinghe and Alex Richardson)
