The impact of Federal Reserve rate cuts on global markets
By Farzad Vajihi – Analyst of stock market and cryptocurrency, Ph.D. in economics.
The Federal Reserve (Fed) plays a pivotal role in shaping global financial markets through its monetary policy decisions, particularly when it comes to setting interest rates. A rate cut by the Fed—a decision to lower the federal funds rate—has far-reaching implications, not just for the U.S. economy but for economies and markets worldwide. Here’s why a Fed rate cut is significant on the global stage.
The global financial system is deeply interconnected, and major economies often align their interest rate policies to avoid unwanted capital inflows or outflows that could destabilize their financial markets.
On the other hand, the looming U.S. election is a complicating factor for global investors and rate setters who are hoping for another 0.5 interest rate cut from the Fed and an economic soft landing.
In this paper, we look at what is in focus for world markets:
Following 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 are finally starting to provide comfort to regions facing weaker economies than the United States. Traders increased bets for rate reductions by other central banks as Fed rate-cut expectations grew until the end of the year.
Yet they expect fewer cuts in Europe than for the Fed, with the ECB and Bank of England sounding more vigilant around remaining inflation risks.
Starting the Fed’s rate cuts 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 give emerging market central banks more room for maneuvers to ease themselves and support domestic growth.
Around half of the sample of 18 emerging markets 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 significantly impact fiscal policies, potentially leading to varied and more idiosyncratic actions by central banks.
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, 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, 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.
We always have a wobbly market around the rate cuts because the market wonders why central banks are cutting and If we have a cut without a recession, which is the mid-cycle script, usually the markets tend to go back up, and the bank favored sectors benefiting from lower rates, such as real estate and utilities.
Time OF Shine
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
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.
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.
