The Fed’s decision to cut interest rates stirred mixed feelings from those in the industry, but what does it mean for advisers and the US economy?
The decision of the US Federal Reserve to cut interest rates on September 19 was not unexpected, though choosing to reduce the rate by 0.5 per cent was, and it caused the US equity market to reach a record high within hours.
Jeffrey Cleveland, economist at US asset management firm Payden and Rygel, said on the surface at least, one would not expect policy makers to cut rates right now.
He told FT Adviser: “If you see an economy where GDP is growing at 3 per cent, and unemployment is very low, loosening monetary policy is not what typically happens.”
But he said with inflation at a level where even if it does not fall “it’s not a problem”, cutting rates may not add significantly to the inflationary pressures in the economy.
I have seen some in the market describe this rate cut as a pre-emptive strike to protect the economy, but I would argue they were a bit late to act
Richard Flax, chief investment officer at wealth management firm Moneyfarm, said a 0.5 per cent cut in US interest rates typically only happens “during a crisis, at least in recent years”.
With that in mind he says Federal Reserve governor Jerome Powell has the task of reassuring the market that a cut of that magnitude was needed, but also that an economic crisis is not imminent.
Flax said: “The US economy is still pretty robust, as evidenced by some decent retail sales figures. Unemployment is rising, but from low levels. Jobs are still being created and real wages are growing quite nicely.
“On the other side of the argument, we’ve clearly seen the labour market softening – unemployment is rising after all and jobs aren’t as plentiful as they once were. And that deterioration could clearly pick up steam.
He added: “At the same time, the Fed hasn’t really given up very much by cutting 50 bps now. Fed chair Powell was at pains to stress that 50 bp cuts aren’t ‘the new pace’ for the US Central Bank. Market expectations for where the policy rate will be at the end of the year didn’t move very much in the wake of the announcement.
“So, it looks like the Fed has managed to send a strong signal that it will support the labour market, while keeping expectations for future rate cuts under control.”
Bryn Jones, head of fixed income at Rathbones Investment Management, said that while some economic data in the US is positive, a rate cut may have been overdue.
He said: “Money supply has shrunk. Household savings have fallen markedly, unemployment is up, and inflation is down. I have seen some in the market describe this rate cut as a pre-emptive strike to protect the economy, but I would argue they were a bit late to act.”
Cleveland added that while the US economy is in robust health, “there has definitely been a slowdown, the unemployment rate remains very low, but there are also signs of weakness there”.
But George Brown, senior US economist at Schroders, was more upbeat about the health of the US economy.
He said one reason the jobs data in the US has weakened is that migration has increased, so the number of workers has increased at a faster pace than the number of available jobs.
However, as the number of available jobs remains robust, he does not regard this as a problem.
Cleveland said that whereas a year ago the US economy was generating 250,000 new jobs per month, the number is now around 120,000 per month.
Gerit Smit, who runs the Stonehage Fleming Global Best Ideas fund, said the move to cut rates now is to “protect” the US economy, and added that with interest rates still at 5 per cent, there is plenty more scope to cut if economic conditions deteriorate further.
What next?
In terms of what comes next, Brown said while the US economy is performing well, the bigger issues, such as the size of the deficit, remain unaddressed.
He commented that the budget deficit in the US is high considering the extent of recent GDP growth and the low rate of unemployment.
Deficits should be falling when unemployment is low as tax revenue is going up, while unemployment benefit and other social costs come down.
Economists call this effect the fiscal stabiliser.
Rising budget deficits at a time of low unemployment would usually be expected to be inflationary, as they inject demand in to an economy that may already be near to full capacity.
Stock markets were quick to embrace the significance of the rate cut, with the S&P 500 hitting a record high, and the dollar weakening.
Jones said that, from a bond market perspective, he expects a short-term rally in riskier bonds as a result of the rate cut, but he believes if rate cuts keep happening, this could spook markets into fearing a recession and lead to a sell-off of risks assets.
Brown said equity markets rallied as investors were reassured that a recession is not imminent but also benefit from the risk free rate being lower.
david.thorpe@ft.com