Fast reading
- The European Central Bank cut rates by 25bps on Thursday and the US Federal Reserve is widely expected to follow suit next week.
- Trading has been volatile this month as investors fret about the US economy.
- US inflation fell to 2.5% in August, according to data released on Wednesday.
Global stocks regained ground this week following the European Central Bank’s decision to cut rates on Thursday and on anticipation that the US Federal Reserve will also reduce borrowing costs at its policy meeting next week.
The pan-European Stoxx 50 Index closed up 1% on Thursday, while the UK’s FTSE 100 ended up 0.5% following a rebound in US stocks on Wednesday that saw the tech-heavy Nasdaq Composite rise 2.2% and the blue-chip S&P 500 close up 1%1. Trading has been volatile this month as investors fret about the strength of the US economy.
“The US Federal Reserve is behind the curve but poised to get moving at its meeting next week. All the jobs-related data of the last three months is telling us what the American consumer, particularly the lower-end consumer, already knows: the economy is softening, particularly the private sector,” says Steve Auth, Chief Investment Officer for Equities at Federated Hermes.
The Fed needs to cut by 50bps next week, but probably won’t.
US inflation fell to 2.5% in August, according to data released on Wednesday2, adding to expectations that the Fed will cut rates by 25bps next week. The federal funds rate is currently in the 5.25-5.5% range, a two-decade high.
“The Fed needs to cut by 50bps next week, but probably won’t. If they don’t, the next six weeks of data will likely push them to do so in November, and, for sure, we are now entering a prolonged cutting cycle. While this is bullish for cyclicals and value stocks, in the near term, markets may continue to fret that the Fed is behind the curve,” Auth adds.
Election uncertainty
Lewis Grant, Senior Portfolio Manager for Global Equities at Federated Hermes Limited, says concerns about the US economy have fuelled market volatility in recent months, a trend he expects to persist ahead of the US election in November. Amid tight polls, Donald Trump and Kamala Harris held their first presidential debate in Philadelphia on Tuesday.
“The first presidential debate, long anticipated by both markets and the electorate, offered little in the way of substantive policy clarity. Uncertainty around which of the candidates’ economic agendas will come into force – and even what those agendas will truly be – will weigh on market sentiment,” Grant adds.
Sluggish growth across the eurozone and cooling inflation – which fell to 2.2% in August – may have encouraged the ECB is cut its deposit rate by 25bps from to 3.5% on Thursday. It was the ECB’s second reduction this year following its landmark cut in June.
Figure 1: The ECB has cut rates for the second time this year
EM squeeze
Global markets registered higher-than-usual levels of volatility in August because of the rising risk of a recession in the US, the speedy appreciation of the Japanese yen, and doubts about monetisation of the artificial intelligence (AI)-theme, says James Cook, Investment Director for Emerging Markets at Federated Hermes Limited.
“Emerging Market equities suffered as investors lowered their risk appetite, notably names in the technology space,” he says. The MSCI EM Index has slipped 3.6% month to date3.
However, as the Fed begins to turn dovish in its actions, the US dollar should weaken, which should instil positive conditions for China and Hong Kong in the form of Chinese yuan appreciation, alongside Turkey, South Africa, and Southeast Asia as monetary conditions loosen, Cook says.
“Brazil, Mexico, and Chile have room to cut interest rates aggressively once the Fed moves if the fiscal situation permit. Southeast Asian economies will also benefit from looser monetary policies,” he adds.
For further insights on emerging market equities please see: GEMs Equity Outlook, H2 2024
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1 Bloomberg as at 12 September.
2 US inflation falls to 2.5% in August (ft.com)
3 Bloomberg as at 12 September.
