While waiting for rate cuts
LAST year, the US Federal Reserve Bank, the Fed for short, announced that in 2024 it would cut interest rates from the highest level in more than 20 years. It did not say precisely when, but based on the indications at that time the mid-year was a good forecast.
However, a majority in the American bond market had long made the bet that the Fed would cut interest rates faster than the central bank expected itself, and this is actually an interesting position.
The market optimism carried into this year, so much so that the chairman of the Fed, James Powell, cooled markets down on January 31. It was a sort of ad hoc press conference, which for me confirmed that he found it necessary to communicate.
A month ago, there was leading speculation of a US rate cut in March, but this was clearly called off by the central bank head. Of course, it disappointed a major part of Wall Street, though the message was explained more in detail when the minutes from the latest monetary policy meeting were released on Wednesday, February 21.
Words from the Fed excite not only investors on Wall Street. Many around the world are waiting for rate cuts, including central banks and governments in emerging markets. And what did the Fed say?
The main focus remains on inflation, which the US central bank finds is still too high. The minutes confirm that this really is in focus and therefore the Fed investigates all inflation components in detail. The short version of my conclusion about the minutes is a recognition
by the Fed that some components are pointing to lower inflation.
The communication from the Fed balanced the markets toward rate cut expectations in June this year; it also confirms that the next rate move remains a cut.
This is what I would describe as a balanced view, and it is also my primary view. It means my expectations currently are very much in line with general expectations in the financial markets. It is also my assessment that these expectations are representative of a broad share of the financial markets. Said another way, almost all of us in the financial markets expect the same.
Decades of experience have shown that such market situations are where risks can create very volatile situations because close to all financial market participants will be surprised if reality turns out to be different from the expectations. But is it likely at all?
In financial markets, everything is always possible and — as mentioned — it is a risk alone that all market participants expect the same. One definition of risk is that it simply is equal to the unexpected that happens. In my view, the biggest risk is that inflation shoots up again.
The global economy is most likely to gear further down this year; not dramatically, but it is the direction. A part of the story is weaker industrial production in many countries, a development that will reduce inflation pressures further. Food prices are currently also under control, though nature is unpredictable, so food production can suddenly disappoint.
Energy prices are also balanced for the time being. I see risks on the upside that are linked to the Russian war on Ukraine and the conflict in the Middle East. Yes, energy prices are a risk that concerns part of inflation, though they are not alarming right now.
Apart from inflation pressure coming down slowly, I am very convinced that the Fed will cut the rates as soon as possible. It will be too painful for the central bank if it can be claimed that it provoked the US economy into even lower growth because interest rates stayed too high for too long.
It is not the situation yet but what I describe I regard as an important force to cut interest rates as fast as possible. Until then it is just about waiting, because the rate cuts will come.
Peter Lundgreen is the founding CEO of Lundgreen’s Capital. He is a professional investment advisor with over 30 years of experience and a power entrepreneur in investment and finance. Lundgreen is an international columnist and speaker on topics about the global financial markets.