Yesterday the US Federal Reserve cut the Fed Fund rate by 0.50%, which was on the higher end of market expectations.
In recent years, the US economy has been the beneficiary of growth in tech, energy and defence sectors, therefore outperforming many other countries despite the large global interest rate rises starting in 2021.
However, interest rate sensitive components of the US economy such as consumer spending and business investment have been affected, and consequently, the economy has begun to cool.
As the US economy has slowed, inflation has been brought under control (Figure 1 below) whilst unemployment has begun to drift higher (Figure 2 below).
The US Federal Reserve is mandated to maintain maximum employment and stable prices, therefore it’s no surprise that US rates needed to come down to provide support to a slowing economy.
Annual US CPI (%)
Figure 1 - US CPI (Source: Bloomberg)
US Unemployment Rate (%)
Figure 2 - US Unemployment Rate (Source: Bloomberg)
Yesterday the US Federal Reserve signalled via their “Dot Plot” that they see Fed Funds’ averaging at 3.375%over 2025 - indicating significant cuts to come. Whereas the market is pricing in 3% by August 2025.
The market had widely anticipated the Fed beginning its rate cut cycle, and paradoxically both the equity and bond market had an initial minor sell off on Wednesday. This is somewhat of a “buy the rumour, sell the fact” outcome. The reaction is linked somewhat to short-term positioning and is probably short lived.
The flow on effect to equity markets
The US Fed is the largest single driver of global monetary conditions, and although cuts have been expected by equity and bond markets alike, it’s likely that the more benign interest rate environment initiated yesterday will underpin equities.
The potential impact on fixed interest markets
Bond markets have already priced in significant cuts, and it’s not immediately apparent how much further they can rally in the very short term. The US Federal Reserve Chair Jerome Powell has indicated that rates will continue to fall, but not to the extent of the previous era of ultra-low rates, therefore at this stage we can view this decision with cautious optimism only.
In the Kernel NZ fixed interest funds, we continue to stay nimble and focus on high risk-reward opportunities.
This blog was written by Matthew Winton, Kernel’s Fixed Interest Portfolio Manager. You can see our Fixed Interest Fund Range below.
