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The 30-share BSE index Sensex plunged by 609.68 points to close at 85,102.69. The 50-share NSE index Nifty declined by 225.90 points to settle at 25,960.55. File.
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When the Federal Reserve delivers a widely-anticipated interest rate cut on Wednesday (September 18, 2024), its first in four years, the move will resonate well beyond the United States.

The size of a first move and the scale of overall easing remains open to debate, while a looming U.S. election is another complicating factor for global investors and ratesetters looking for a steer from the Fed and pinning hopes on an economic soft landing.

“We don’t know yet what kind of cycle this is going to be—will it be like 1995 when there was just 75 bps of cuts or 2007-2008, when there was 500 bps,” said Kenneth Broux, head of corporate research, FX and Rates at Societe Generale.

Here’s a look at what is in focus for world markets:

Follow the leader

In spring, as U.S. inflation proved stickier than expected, investors questioned how far others such as the European Central Bank or the Bank of Canada could cut rates if the Fed stayed on hold this year before their currencies weakened too far, adding to price pressures.

U.S. cuts finally starting comforts regions facing weaker economies. Traders added to bets for rate reductions by other central banks as Fed rate-cut expectations grew recently.

Yet they price fewer cuts in Europe than for the Fed, with the ECB and Bank of England sounding more vigilant around inflation.

Confidence in Fed cuts starting is a boon for bond markets globally that often move in lock step with Treasuries. U.S., German and British government bond yields are all set for their first quarterly fall since end-2023, when a Fed pivot was anticipated.

Breathing space

Lower U.S. rates could give emerging market central banks more room for manoeuvre to ease themselves and support domestic growth.

Around half of the sample of 18 emerging markets tracked by Reuters have already started cutting rates in this cycle, front-running the Fed, with easing efforts concentrated in Latin America and emerging Europe. But volatility and uncertainty around the U.S. Presidential election clouds the outlook.

“The U.S. election will have a major bearing on this because, depending on various fiscal policies, it really complicates the cutting cycle,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas. “We could see more idiosyncratic actions among central banks on the back of that.”

Strong dollar reprieve

Those economies hoping U.S. rate cuts will weaken the robust dollar further, lifting their currencies, may be disappointed.

JPMorgan notes the dollar has strengthened after a first Fed cut in three out of the last four cycles.

The dollar outlook will be driven largely by where U.S. rates are relative to others.

The safe-haven yen and Swiss franc could see their respective discounts to U.S. rates almost halve by end-2025, Reuters polls suggest, while sterling and the Australian dollar may only acquire a marginal yield advantage over the dollar. Unless the dollar becomes a real low-yielder, it will continue to hold its appeal among non-U.S. investors.

Asian economies, meanwhile, have led markets’ front-running of U.S. cuts, with South Korea’s won, the Thai baht and Malaysian ringgit surging through July and August. China’s yuan has wiped out year-to-date losses versus the greenback.

Rally on

A global equity rally, which faltered recently on growth fears, could resume if lower U.S. rates boost economic activity and means recession is avoided.

World stocks tumbled in early August following weak U.S. jobs data. “You always have a wobbly market around the first cut because the market wonders why central banks are cutting,” said Barclays head of European equity strategy Emmanuel Cau.

“If you have a cut without a recession, which is the mid-cycle script, usually the markets tend to go back up,” Cau said, adding that the bank favoured sectors benefiting from lower rates, such as real estate and utilities.

A U.S. soft landing should also play well in Asia, although the Nikkei has fallen more than 10% from July’s record high on a rising yen and as Japan’s rates rise.

Time to shine

In commodities, precious and base metals such as copper should benefit from Fed rate cuts, and for the latter the demand outlook and a soft landing are key.

Lower rates and a weaker dollar, reducing not just the opportunity cost of holding metals but also of buying them for those using other currencies, could fuel momentum.

“High rates have been a critical headwind to base metals, driving a significant negative physical demand distortion from destocking and weighing on capital intensive end-demand segments,” said MUFG’s Ehsan Khoman.

Precious metals could also gain. Gold, which typically has a negative relationship with yields as most demand is for investment purposes, usually outperforms other metals during rate cuts. It is at record highs, but investors should be cautious, said the World Gold Council’s John Reade.

The Japanese sold bonds while purchasing stocks.ap
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Japanese investors net sold foreign bonds for the second consecutive month in July, deterred by declining bond yields in the United States amid heightening expectations of an imminent rate cut by the U.S. Federal Reserve to support the faltering American economy.

Net sellers

According to data from Japan’s Ministry of Finance, Japanese investors offloaded 1.49 trillion yen ($10.12 billion) in long-term overseas bonds following a substantial net disposal of 3.35 trillion yen in the previous month.

They also shed approximately 17 billion yen in short-term instruments.

Meanwhile, domestic investors bought a net 724.2 billion yen in foreign equities last month, reversing two consecutive months of net selling, according to the data from the Japanese Finance Ministry.

British multinational bank Barclays noted that the recent inflows largely continue the trend of significant purchases by investment trusts since the beginning of the year, likely fueled by new Nippon Individual Savings Account flows, coupled with a cessation of substantial sales by trust accounts due to the Japanese currency’s appreciation and a stalled equity rally.

‘Largest purchase’

Data revealed that investment trust management companies acquired a significant 1.14 trillion yen in overseas equities, marking their largest monthly net purchase since January this year.

Conversely, banks and life insurers sold a net 466.4 billion yen and 15.2 billion yen worth of overseas stocks, respectively, data show.

A woman shops in a supermarket in Los Angeles, California, U.S. File
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U.S. monthly inflation was unchanged in May as a modest increase in the cost of services was offset by the largest drop in goods prices in six months, drawing the Federal Reserve closer to start cutting interest rates later this year.

The report from the Commerce Department on Friday also showed consumer spending rose marginally last month.

It raised optimism the U.S. central bank could engineer a much-desired “soft landing” for the economy in which inflation falls without triggering a recession and a sharp rise in unemployment. Traders raised bets for a Fed rate cut in September.

‘Better behaved’

“It helps the argument inflation is looking better-behaved, which may well open the door to interest rate cuts later in the year,” said James Knightley, chief international economist, ING. The flat reading in the personal consumption expenditures (PCE) price index last month followed an unrevised 0.3% gain in April, the Commerce Department’s Bureau of Economic Analysis said.

Goods prices dropped 0.4%, the most since November. There were big declines in prices of recreational goods and vehicles as well as furnishings and durable household equipment. The price of gasoline and other energy goods dropped 3.4%. Clothing and footwear were also cheaper last month.

The cost of services rose 0.2%, lifted by higher prices for housing and utilities as well as healthcare.

A file photo of the U.S. Federal Reserve
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The U.S. Federal Reserve report released on March 1 flagged a range of what it deemed “notable” vulnerabilities in the financial markets while adding the stress that roiled the banking sector a year ago has faded considerably.

The Fed also used the latest release of its periodic Monetary Policy Report to say that officials will not start moving their short-term interest rate target down until they gain greater confidence inflation is truly moving back to the 2% target.

In the report, the central bank noted several ways in which borrowing levels, or leverage, were increasing risks in the financial sector. It also said stock prices were “close to historical highs.”

The Fed said leverage at hedge funds had stabilized at high levels, while life insurers were facing a situation where they were becoming more reliant on non-traditional sources of funding.

Banking system is sound, says Fed

Meanwhile, while banks’ sources of funding remain liquid and stable, funding costs were on the rise, the central bank said. But even with those rising challenges, the Fed report said “the banking system remains sound and resilient” and “acute stress in the banking system has receded since last spring.”

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A year ago, the Fed contended with bank problems of a magnitude that forced it to launch a new liquidity facility, amid surging demand for central bank credit. Much of that borrowing has faded away as a major concern for markets and the central bank, and the Fed will close this month the Bank Term Funding Program stood up to deal with the troubles.

The Fed report said credit remains available for most who want it, while acknowledging borrowing’s high expense: “Interest rates on both credit cards and auto loans remain higher than the levels observed in 2018 at the peak of the previous monetary policy tightening cycle.”

Inflation under watch

On the economy, the Fed reiterated it was committed to getting inflation pressures back to its target and said the rate-setting Federal Open Market Committee “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.”

Also read: American consumers are pushing back against high inflation — and they are winning

Fed forecasts from the close of last year, buttressed by officials’ comments, have all pointed to rate cuts this year amid falling inflation pressures. However economic strength and an uneven path back to 2% have pushed back market expectations of when the easing will start, likely toward the summer.

The Fed’s twice-yearly report to Congress comes ahead of two days of testimony by Fed Chair Jerome Powell set for Wednesday and Thursday next week. Mr. Powell is likely to face a barrage of questions from lawmakers about the Fed’s tight policy stance and expectations for easing it, a sensitive topic in a presidential election year.

The report generally recaps economic developments and actions taken by the Fed in the period since the previous update given to lawmakers. Fed concerns over financial markets’ vulnerabilities had already been noted in the release of meeting minutes for the January FOMC meeting, released last week.

At the Fed’s most recent policy meeting in January, central bank staff briefed policymakers on their assessment of stability within the U.S. financial system, with the minutes saying staff “characterized the system’s financial vulnerabilities as notable.”

A number of congressional Democrats have already been hounding Mr. Powell over high rates, complaining they are exacerbating already-poor housing affordability for low- and middle-income households. Republicans, meanwhile, have been critical of the Fed’s initially slow response to inflation and could chastise Mr. Powell over indications he may lower rates ahead of the November election.

Rate cuts ahead of the presidential elections?

The Fed’s next interest rate-setting meeting is scheduled for March 19-20, and policymakers are widely expected to leave their benchmark policy rate unchanged at 5.25%-5.5%, where it has been since July.

The upcoming meeting will also bring updated forecasts on inflation, employment, growth and interest rates. In December, the Fed pencilled in three rate cuts, and in comments to reporters on Wednesday, New York Fed leader John Williams said that outlook is a “reasonable” place for Fed officials to think about the monetary policy outlook.

However, the timing of action remains in question. After a benign run of inflation data through the second half of 2023 led financial markets initially to position for rate cuts as early as the March meeting, the first set of inflation readings for 2024 has at least temporarily stalled some of that momentum on taming the pace of price increases.

Market pricing now reflects a prevailing view that the first cut will occur in June, although a first cut at the April 30-May 1 meeting is not out of the question.

The World Bank’s chief economist warned Wednesday that interest rate hikes could spell trouble for countries struggling to deal with debt.

The U.S. Federal Reserve, the European Central Banks and others have raised rates and warned that they could remain high longer than expected in order to bring down elevated inflation.

The International Monetary Fund said Tuesday that the world economy remains resilient despite the fallout from Covid, the war in Ukraine and a cost-of-living crisis, but that it was “limping along, not sprinting.”

“In spite of all of these shocks, we have not seen any big economies really get into trouble. But the good news basically ends there,” said World Bank chief economist Indermit Gill.

“The trouble now is that because of the high rates, the high interest rates that you mentioned, growth is slowing down a lot,” he said at a news conference during the IMF-World Bank annual meetings in Marrakesh, Morocco.

Mr. Gill recalled that during another long period of high interest rates, in the 1970s, around 24 economies were left bankrupt.

“We should expect this tightening cycle to also take long,” he said. “We should expect some countries to (get) into trouble.”

World Bank President Ajay Banga said there was “no doubt” that inflation has begun to come down but that rates will stay higher for longer.

“That can be a complicated event in many ways for investments as well as to people who over the years have got used to a low interest rate environment,” Mr. Banga said.