Fed finally folds with fifty

At the previous Federal Open Market Committee on 31 July 2024, Governor Jerome Powell set the market up for a turn in the interest rate cycle. He noted at that meeting that the second quarter inflation readings had added to their confidence and that the labour market appeared to be normalising. If any future labour market concerns should arise, he assured that the Federal Reserve was well-positioned to respond. However, a 50 basis point (“bp”) cut was not what the Fed was thinking about at that point in time. One could argue that not much changed over the seven weeks since that meeting but the Fed chose to cut the target of the Fed Funds rate by 50 basis points at its September meeting to front load its policy easing (the navy blue line in the chart below).

Selected central bank policy rates (Fed – navy blue, SARB – green)

Source: FACTSET

The 25bp – 50bp rate cut debate occupied much airtime and column space over the past fortnight but the 50bp expectation was probably shading the scorecard going into the final round. On Wednesday, the American markets bided their time before the policy announcement with the S&P 500 trading in a 27 point range in the first four and a half hours of trading. On the news of the 50bp cut the S&P 500 jumped 40 index points and then, in a volatile period of trade, gave up all those gains to be down 53 index points from the intraday high. The market then attempted another rally but when all was said and done at the end of the trading day, the index closed down at 5,618 points for a 0.29% loss on the day.

S&P 500 index on Wednesday (one minute ticks) – FOMC announcement at 8pm SAST

Source: FACTSET

The FOMC meeting was accompanied by the quarterly release of the Fed’s Summary of Economic Projections, more commonly known as the “Dot Plot” (see table below). The median expectation of the FOMC members for the Federal Funds rate at end-2024 was cut to 4.4% from 5.1% at the previous quarterly reading. That leaves room for another 50bp of easing this year with two more meetings to go (7 November and 18 December announcements).

Federal Reserve Bank’s Summary of Economic Projections

Source: Federal Reserve

The FOMC statement concluded with “The Committee has gained greater confidence that inflation is moving sustainably toward two percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.” The statement is a calming one but one does have to question whether or not the 50bp cut was more a sign of a little panic at being behind the policy easing curve. The market gyrations post the announcement reflected a market uncertain on how exactly to react to the rate cut and the accompanying dot plot. In the long run it's probably not going to matter much at all. The Fed has begun its easing path and the market and the Fed seem to be fairly in synch as far as longer-term expectations go. The exact timing and size of each rate cut might be difficult to predict with certainty but the outcome is going to be a shallower cutting cycle and one that is not going to see rates back anywhere near zero percent. A central bank is never going to please everybody all of the time and may even upset everybody at some point in time. For all the opposition that comes its way, the Fed has managed over the past two decades to steer the US economy through the Great Recession, the COVID pandemic and numerous other potential banking crises. They have been willing, on this occasion, to adjust policy a little more heavily than usual to maintain the behemoth US economy on an even keel and one should not expect anything different in future if the need arises.

Over the medium-term, the lower interest rates and the consequent (hopefully) economic growth should be positive for equities. Third quarter earnings growth is expected to slow marginally when the numbers are reported over the course of October and December but the longer-term earnings growth story looks to be intact. That is further support for the market particularly given that the source of that earnings growth is coming from industries other than  semiconductors and weight-loss drugs.

With the Fed’s job now done (for this month), all eyes turn to the Monetary Policy Committee of the South African Reserve Bank. Would Governor Lesetja Kganyago be just as bold with a 50bp cut? That might not be the consensus market expectation but there is no reason why he could not follow suite. The Headline CPI (4.4% y/y) and the Core CPI (4.1% y/y) are below the midpoint of the inflation target range, the SARB’s Quarterly Projection Model sees CPI at or below that midpoint beyond 2025 and market inflation expectations have been moderating. The SARB has a single mandate to protect the internal and external value of the rand but a glance at the limping domestic economy would not hurt the case for a bit of central bank boldness. Unlike the Fed, the SARB will only meet one more time this year (21 November announcement) and may want to get a little momentum going before we head into 2025. The impact of the funds released from the two-pot system on inflation and growth, albeit temporary, might be something the SARB would want to keep an eye on but that should not necessarily stand in the way of a cut a little more meaningful than 25bp. Let us have an Airbus A380 on standby just in case we need to fly over the podium at the Reserve Bank building on Thursday afternoon.