Even before the Federal Reserve approved its outsized half-percentage-point interest rate cut last week, financial markets had begun making credit cheaper for households and businesses as they bid down mortgage rates, cut corporate bond yields, and chipped away at what consumers pay for personal, auto and other loans.

How fast that process will continue now that the U.S. central bank's first rate cut is in the books is unclear, in particular whether easing credit conditions will become tangible to consumers in ways that shift attitudes about the economy before the Nov. 5 U.S. presidential election.

Recent surveys suggest that while the pace of price increases has declined dramatically, the public's mood is still marred by nearly two years of high inflation - even if falling rates signal that chapter of recent economic history is closed and will begin making it cheaper for people to borrow money.

"My daughter has been trying to buy a home for years and cannot," said Julie Miller, who works at her son's electrical company in Reno, Nevada, a state where home prices rose fast during the COVID-19 pandemic. One of seven key battleground states in the presidential race, Nevada is being aggressively contested by Vice President Kamala Harris, who replaced President Joe Biden as the Democratic candidate, and former President Donald Trump, the Republican challenger.

If housing costs are vexing Miller's daughter, higher prices at Taco Bell have caused Miller to cut back on the usual Friday night trips to the fast food retailer with her granddaughter, and left her inclined to vote for Trump because "I don't think Biden has done a great job with inflation."

Harris supporters had similar concerns about high prices even as they vouched for her as the best candidate to address the problem.

BORROWING COSTS DECLINE

The Fed's rate cut on Sept. 18 is likely to be followed by more, with at least another quarter-percentage-point reduction expected when policymakers begin their next two-day policy meeting a day after the U.S. election.

Just as rate increases feed through to a higher cost of credit for families and businesses, discouraging them from borrowing, spending and investing in order to cool inflation, reductions in borrowing costs change the calculus for would-be homebuyers and firms, particularly small businesses wanting to finance new equipment or expand production.

Looser monetary policy, which the Fed had been signaling was on the way, has already put money back into people's pockets. The average rate on a 30-year fixed-rate home mortgage, the most popular home loan, for example, is approaching 6% after nearing 8% just a year ago. Redfin, a real estate firm, recently estimated that the median payment on homes sold or listed in the four weeks through Sept. 15 was $300 less than the all-time high hit in April and nearly 3% lower than a year ago.

Indeed, under baseline estimates from the Fed's own staff, mortgage rates are likely to level off somewhere in the mid-5% range, meaning most of the relief there has already occurred.

Banks have begun trimming the "prime rate" they charge their most credit-worthy borrowers to match the Fed rate cut. Other forms of consumer credit - the auto and personal loans where a better deal might be available to households - have changed only marginally so far, and it may take longer for banks to give up on charging higher finance costs.

Investors and economists saw last week's rate cut as less important than the message it carried of a central bank ready to loosen credit and confident that recent high inflation won't recur.

Inflation in fact has registered one of its fastest ever declines, with the consumer price index's annual increase falling from more than 9% in June 2022 to 2.6% on a year-over-year basis last month. The Fed's preferred personal consumption expenditures price index rose at a 2.5% rate in July, near the central bank's 2% target.

SOUR SENTIMENT

The U.S. economy has been performing reasonably well despite concerns the job market might be on the brink of weakening.

New claims for unemployment benefits remain low and unexpectedly fell in the most recent week, while the unemployment rate, at 4.2% in August, has risen from a year ago but is around the level the Fed feels is sustainable without generating excess wage and price pressures. A Philadelphia Fed index of manufacturing rose recently and retail sales for August grew despite expectations for a drop.

But none of that has led to a decisive shift in public sentiment.

The share of Americans who see the economy as heading in the right direction climbed to 25% in August from 17% in May 2022, according to Reuters/Ipsos polling. Yet the share that sees the economy on the wrong track has eased to 60% from 74% over the same period.

A New York Fed survey that through early this year showed people feeling better off than a year ago and expecting more improvement in the year ahead has since been moving in the other direction even as inflation slowed further and rate cuts became more likely.

The University of Michigan's consumer sentiment index had been improving but then dropped in recent months and remains below where it was before the pandemic.

The most recent U.S. Census "pulse" polls of households showed the share who reported trouble paying household expenses in the past week has ebbed from 2022, when inflation hit its peak, but has made little improvement recently.

In his press conference following the rate cut last week, Fed Chair Jerome Powell said his aim was to keep the economy on track between the central bank's two goals of stable inflation and a healthy job market. To that end, credit will ease but at no guaranteed pace.

"This is the beginning of that process," Powell said. "The direction ... is toward a sense of neutral, and we'll move as fast or as slow as we think is appropriate in real-time."

Source: Theedgemarkets

The BoE is much more cautious than the Fed

What was striking about the Bank of England decision is how different the messaging was compared to the Federal Reserve. The Bank has kept rates on hold in an 8-1 vote and the language in the statement makes it abundantly clear that it’s not in any hurry to lower rates. By promising a “gradual approach” to rate cuts, the Bank is effectively endorsing quarterly rate cuts of 25 basis points. That suggests the next cut is highly likely in November.

None of this is particularly surprising, but it does beg the question of whether the Bank of England’s easing cycle needs to look that different to that of the Federal Reserve. Markets, for some time, have concluded that it will. There are fewer cuts priced this year relative to the US and the terminal rate is some 40-50bp higher too.

It’s easy to see why. Not only is the BoE sounding more hawkish, UK services inflation is higher than in the US and eurozone, and at face value, it is going in the wrong direction.

The Bank’s hawks worry that corporate price and wage-setting behaviour has permanently shifted in a way that’s going to make it perpetually harder to get inflation down on a sustained basis. We’re not convinced that’s the consensus view on the committee right now – August’s decision to cut rates certainly suggests it isn’t. But so long as wage growth and services inflation remain sticky, then the committee as a whole seems happy to tread carefully.

We think BoE rate cuts will accelerate beyond November

We’re less convinced that the UK’s easing cycle will deviate that much from the Fed or others. As the Bank readily concedes, the recent stickiness in service sector inflation is mostly down to volatile categories that hold little relevance for monetary policy decisions. Strip that out, and the picture is slowly looking better.

Meanwhile, the jobs data, though admittedly of dubious quality right now, points to an ongoing cooldown too. The number of payrolled employees appears to be falling now and that will inevitably feed through to wage growth. Companies are consistently lowering their estimates of expected and realised price/wage growth, according to a monthly BoE survey.

We therefore think that Bank of England rate cuts will accelerate after November. Beyond then, we think the Bank will grow more confident in the persistence of inflation and there will be sufficient consensus on the committee to switch to back-to-back rate cuts. Like investors, we expect a cut in November and December, with further cuts in 2025 taking us to 3.25% by the end of next summer.

BoE stays the course on quantitative tightening (QT)

Besides the decision to hold rates unchanged, the BoE also decided to continue reducing the size of its asset portfolio by £100bn over the coming 12 months. Of this amount, £87bn will come from maturing Gilts, and thus relatively little will come from active bond sales. There was some talk that this pace could be increased, but ultimately the Committee seems to prefer maintaining a predictable path going forward. Remember the Bank wants this to be a background process, which allows Bank Rate to remain the active tool for controlling monetary policy.

The impact on market rates will be minimal from the decision to keep the current pace, bearing in mind that this was also the consensus view. QT will continue to play a role in the term risk premium, but we are likely talking in the range of about 10bp for the 10Y yield over the next year. Regarding liquidity conditions, QT should be less impactful, because the BoE’s short-term liquidity facility (STR) has shown significant uptake of late (£44bn) which is helping to mitigate the risks of QT abruptly draining too many reserves from the system.

The Malaysian ringgit is poised to extend its rally after what’s likely to be its best quarter since 1973 as the central bank will probably refrain from cutting interest rates.

The ringgit has risen more than 12% against the dollar so far this quarter, making it the best performing emerging-market currency. Narrowing rate differentials with the US, improving trade performance and attractive asset valuations may help the ringgit strengthen further, analysts said.

Robust economic growth and a potential pickup in consumer prices if the government proceeds to remove some fuel subsidies may keep Bank Negara Malaysia on hold into 2025 even as other central banks start to lower borrowing costs. Foreign investor flows and further conversion of foreign currency deposits will also support the ringgit.

“Malaysia’s current account surplus, neutral central bank stance and stable fundamentals may help with further gains in light of dollar weakness,” said Jeff Ng, head of Asia macro strategy at Sumitomo Mitsui Banking Corp. “This is particularly so if markets expect more rate cuts by the US, reducing yield differentials between the US and Malaysia.”

The ringgit has been on a tear since April after a rebound in exports and efforts by the central bank to encourage state-linked firms to repatriate overseas investment income. The rally picked up steam this quarter as investors bet on Southeast Asian winners amid the prospect of policy easing by the Federal Reserve.

Global funds have poured a cumulative US$2.5 billion (RM10.51 billion) into the nation’s bonds in July and August, and bought US$1.2 billion of local equities since end-June, according to data compiled by Bloomberg.

The ringgit would also benefit from a rotation into Asia after foreign investors were overweight on Latin American currencies over the past year, according to Chandresh Jain, a strategist at BNP Paribas. “This flow should continue for some time,” he said.

Market indicators suggest the current surge in the ringgit may be stretched, signalling a potential consolidation in the near term. Traders will be keeping a close eye on the country’s budget announcement next month for its progress on subsidy reforms and fiscal deficit.

On a longer term basis, “there is no doubt that the ringgit valuation is attractive and cheap, based on effective exchange rate”, said Wee Khoon Chong, a strategist at Bank of New York Mellon.

Source: The edge markets

The Fed commenced its monetary policy easing cycle in aggressive fashion by announcing an almost unanimous decision to cut rates by 50bps. The markets were surprised with the US dollar suffering the most. Both the accompanying policy statement and the press conference were relatively balanced as Chairman Powell tried very carefully to avoid scaring the market by talking down the US economy.

The Fed is probably on a preset course, despite Powell advertising the meeting-by-meeting approach shared by other central banks. The dot plot revealed two additional 25bps rate cuts penciled in by Fed members for 2024, slightly below market expectations for another 72bps of easing this year. What does history tell us about the timing and size of the second Fed cut?

Is it standard practice for the Fed to announce back-to-back rate cuts?

Continuing from a previous special report where six easing cycles were identified since 2000, table 1 below presents the details of the Fed’s first and second rate cuts. As made evident, Fed members decided to cut rates again at the next scheduled meeting in four of the six examined cycles, increasing the possibility for a November 7 rate move.

Interestingly, Fed decisions varied from a 100bps rate cut in 2020, during the outbreak of the Covid pandemic, to just 25bps moves in 2002, 2007 and 2019, when the US economy was not falling off a cliff. Also, the time between the first and the second Fed rate cuts fluctuated from just 13 days in 2020 to almost 8 months in 2002, as the Fed traditionally tries to act appropriately in order to meet its dual mandate.

The next Fed meeting is scheduled for November 7, two days after the US presidential election day. Quite possibly, the result of the election might not be yet finalized, especially if the Republican presidential candidate is losing the battle. This raises the possibility of the Fed refraining from announcing another rate cut until the new president is declared. However, the market is convinced that the November rate cut is a done deal, and it is even assigning a sizeable 43% probability for another 50bps move.

How did the market perform between the first and second Fed rate cuts?

Chart 1 below presents the performance of key market assets in the period between the first and the second Fed rate cuts. Interestingly, dollar/yen dropped by an average of 1.5% in the last five easing cycles, a performance that could repeat this time around as the Bank of Japan is still open to further rate hikes in 2024.

Similarly, US treasury yields tend to fall in the examined time period, with one grave exception. In 2008, yields rose by 20bps as the US administration borrowed heavily from the bond market in order to fund its relief programmes.

Performance for certain assets depends on the underlying economic conditions

As seen in chart 1 below, the remaining assets exhibit a relatively mixed performance. However, digging through the results there is a common pattern emerging in pound/dollar, S&P 500 index, gold and WTI oil price. In periods of distress like 2008 and 2020, these four key assets tend to drop aggressively. For example, the S&P 500 index fell by 5.6% and 20.6% respectively in these two instances, and WTI oil prices collapsed.

In periods of normal economic conditions, like the current situation, the Fed has traditionally opted for a more relaxed approach in terms of its rate cuts. As a result, in 2001, 2002, 2007 and 2019, pound/dollar, S&P 500 index, gold and WTI oil exhibited a stronger tendency to rally. More specifically, the S&P 500 index increased by an average of 2.4% in these four periods, while both gold and WTI oil showed a decent appetite for double-digit jumps.

Putting everything together, dollar/yen and the 10-year US treasury yield tend to decrease in the period between the first and the second Fed rate cuts. The performance of other key assets like pound/dollar, the S&P 500 index, gold and WTI oil depends on the underlying economic conditions. As such, in both 2008 and 2020 these assets dropped aggressively, while during the period between the first and the second Fed rate cuts in 2001, 2002, 2007 and 2019, they recorded strong gains.

Inflation is looking more benign

Core PCE deflator MoM%, 3M annualised, YoY%

Income growth is under pressure

Households are noticing the cooling jobs market and this tends to lead an upswing in unemployment (%)

The jobs market holds the key to the pace of rate cuts

Source: ING

Colombia wants to fuel its transition away from oil and gas with an investment plan worth $40 billion that should replace revenues from hydrocarbon exports.

These are expected to decline after the Colombian government stopped issuing new drilling permits two years ago, Bloomberg reported, citing the country’s environment minister as saying the money would be spent on what the publication called “nature-based climate solutions”, along with low-carbon energy, transport electrification, agricultural practices improvement projects, and projects for biodiversity protection.

“All of this is a huge economic transformation,” the official, Susana Muhamad said. “The portfolio of investments is around developing sectors that we think could start replacing oil revenues.” She added that there were hopes at least $10 billion for the investment pot would come from international institutions and developed countries.

Back in 2022, when he came to power, Colombia’s president Gustavo Petro pledged to shift Colombia’s economy away from oil, coal, and gas, in favour of lower-carbon energy alternatives. At last year’s COP28, Petro became the first leader of a large energy producer to vow phasing out hydrocarbons endorsing a call for something called a Fossil Fuel Non-Proliferation Treaty.

Also at COP28, Petro announced Colombia’s transition policy, which at the time had a price tag of $32 billion. Based on the latest announcement by his environment minister the price of the transition has gone up, which reflects cost troubles in the low-carbon industries.

Despite the bold climate plans, Colombia remains highly reliant on hydrocarbon energy. Earlier this year, a decline in gas production threatened electricity supply shortages, forcing the government to consider LNG imports.

Colombia is also a large exporter of coal and oil, and it would take quite an effort to change that and replace lost revenues with new sources of state income. Meanwhile, the energy ministry plans to boost oil production in the country to 1 million barrels daily, from about 800,000 bpd this year.

Source: OILPRICE