US and UK central banks cut again

Federal Reserve comment – Melanie Baker, Senior Economist

As expected, the Fed cut rates 25bps to 4.50%-4.75%. Guidance on the path ahead was relatively limited (this was not one of the quarterly meetings where we get an updated set of Federal Open Market Committee (FOMC) forecasts) and Powell again described them as not on a preset course, saying that they will continue to make their decisions meeting-by-meeting. However, Powell presented them as still on rate cutting path, but where the pace could be altered as they go along. I don’t think you can rule out a pause in December, but there are several key bits of data before then.

On a rate cutting path: The move today was presented as another step in reducing policy restraint. Although forward guidance was limited and Powell wouldn’t be drawn on whether the September FOMC participant projections still held, he still gave the impression that we should expect several more rate cuts yet. He described them as steering a path towards a more neutral stance, steering between moving too slowly and too quickly. At one point he said they know the destination, but not exactly and don’t know the right pace.

Powell wouldn’t be drawn on whether the September FOMC participant projections still held, he still gave the impression that we should expect several more rate cuts yet.

More generally, he said that it may turn out to be appropriate to “slow the pace” as they approach neutral, but said “We are just beginning to think about that.” In answer to another question about whether he could rule out a rate hike next year, he said that the “our baseline expectation is that we will continue to gradually move towards neutral… but… we not in a world where we can afford to rule things out a full year in advance, there is just too much uncertainty in what we do.”

Could they pause in December – even while still above neutral? Possibly:

• Upbeat tone: One of the striking things (to me) about the press conference were the upbeat descriptions around the economy, going well beyond the statement’s “economic activity has continued to expand at a solid pace.”  He talked about an overall sense that some of the downside risks to the economy were more diminished.
• On the labour market, conditions were described by Powell as “solid” (though also as not as tight as before the pandemic, not a source of significant inflationary pressures and where they, “Don’t need further cooling,” to meet their mandate).
• The Fed aren’t reading much into it yet it seems, but some of the recent inflation data has looked a bit less inflation target consistent (Powell talked about 3 and 6 month inflation rates rather than 1 month and said bumps were expected and that some of the stronger areas like housing services were ‘catch up’ inflation). However, more of the same, and the case for a pause would presumably strengthen. “If the economy remains strong and inflation is not sustainably moving toward 2 percent, we can dial back policy restraint more slowly.” (From the opening statement).
• He said there was nothing in the data that suggests the Committee needs to be in a hurry to get to neutral. He said the right way to find neutral is “carefully, patiently.” While indicating that his words there weren’t meant as a signal (he said they didn’t have a specific meaning.)

The December decision won’t be about Trump (probably), but next year’s decisions could be:

Powell was generally very careful when discussing politics and Trump. He said that in the near term, the election will have no effects on their policy decisions. He said that they don’t know the timing and substance of what policies will be and that they don’t guess, speculate, or assume. When actual policy changes are made, then they will take those into account was the message it seems, and at the moment there was “nothing to model”.

Changes in financial conditions could of course feed through more quickly than actual policy changes – movements in bond yields for example. However, Powell was very clear when asked on financial conditions that changes need to be material and persistent. (In another set of questions he was effectively asked if Trump could push him out. He said “No” to a question about whether he would go if asked, and he said that under the law he couldn’t be demoted.)

Things are more uncertain under a Trump presidency. Looking at Powell’s comments tonight, it sounds as if the December FOMC participant projections may not be very helpful in telling us what Trump’s policies mean for the likely path of rates over 2025 into 2026 (Trump’s inauguration won’t be until late-January 2025). It makes sense I think to assume a bit less cutting/slower cutting than there would have been given the combination of Trump’s key policies should be inflationary. However, with policy measures unlikely to come at once, and uncertainty about how far he will implement his proposed policies, the US monetary policy path may remain unclear for some time.

Federal Reserve – Craig Inches, Head of Rates & Cash

At their recent meeting the Federal Reserve (Fed) cut the policy rate by 25bps to 4.50%-4.75%. This followed the 50bps cut at the previous meeting in September with the market’s main focus to establish whether the Fed would remain on a rate cutting path into year end. This meeting did not provide any updated economic forecasts and therefore the press conference and comments from Chairman Powell were scrutinised to determine the future path of interest rates following the US election.

My key takeaways were that the destination is still unchanged, in that the Fed believe that interest rates are still restrictive and need to decline, however the path that they are taking to get there may become more of a Sunday stroll rather than a route march. Chairman Powell made a series of comments to suggest that the Fed are very much in data watching mode and would not be drawn on any future guidance. On the one hand he talked about a solid and remarkable economy and robust labour market, yet on the other he did not see any significant inflationary pressure nor require things to cool further to continue cutting rates.

Chairman Powell made a series of comments to suggest that the Fed are very much in data watching mode and would not be drawn on any future guidance. 

With regards to the US election, Powell took an almost verbatim approach to the Governor of the Bank of England who had answered these questions only a few hours earlier in the day. He was very clear that until President-elect Trump’s rhetoric becomes reality it is very difficult to forecast the economic effects and therefore this will not influence the Fed’s decisions in the meantime. However, we would expect that this will likely push up future Fed inflation forecasts next year when Trump takes office.

So what did we learn and what now? Well not very much is my view. The market has priced the probability of a rate cut in December at 50:50 and I think that is fair. My own personal view is that we are unlikely to see a rate cut in December and that the Fed will wait until Trump firms up some of his economic policies. I think it is also more likely that we will see a slower moving Fed in 2025. As a result, we continue to favour holding long duration positions in markets such as the UK and Australia, where we would expect to see yields fall faster than the US. On an interesting note, long-dated Japanese bonds now yield in excess of 6% (on a hedged basis) and may begin to appear on the radar of global investors in 2025.

Bank of England – Ben Nicholl, Senior Fund Manager

At last week’s Bank of England (BoE) meeting, the Monetary Policy Committee (MPC) decided to cut UK base interest rates from 5.0% to 4.50%-4.75%, by a majority of 8-1; MPC member Catherine Mann being the only dissenter. Whilst recent fiscal and political events – namely the UK budget and the US election – have seen markets re-appraise and reevaluate their expectations for central banks’ monetary policy over the next 12 to 18 months, expectations for what the BoE might deliver at its 7 November meeting were little changed ahead of the event.

Macroeconomic data has, of late, broadly been in line with both the market and central banks expectations, and there has been little new information to alter the path of interest rates in the very short term. Perhaps the only piece of data to note is that inflation has surprised to the downside versus the BoE’s prior expectations. The decision to cut interest rate by 0.25% was largely seen as a foregone conclusion. However, it is medium-term path of interest rates that will determine the outcome for bond markets from here, and in this respect, the BoE has very much been in the shadow of the UK Budget and the US politics.

The BoE’s central forecast seems to be for a gradual and steady decline in interest rate cuts, as monetary policy moves from being restrictive to somewhat more neutral. Although as yet, there is no guidance from the BoE as to where that neutral level lies. As the dust settles after the UK Budget, and the outcome of the US election is now known, where do the risks to this forecast lie?

Borrowing up, inflation up, and growth down is not a good outcome for bond markets. Gilt yields have risen over the last week, in part due to global events, but with much of the rise due to the market’s assessment on how the budget might impact both the path of interest rates and expected borrowing in future years. The rise in longer maturity gilt yields is a reflection of the market’s view around debt sustainability. The Office for Budget Responsibility (OBR) and the Institute for Fiscal Studies (IFS) have highlighted some key risks to the assumptions and forecasts, particularly around flagship tax revenue generating policies. In addition, the rise in bond yields has already removed much of the headroom the Chancellor had created from the change to the fiscal rules. The conclusion therefore is that the market is nervous about future borrowing, and whether the Chancellor will be back at the dispatch box seeking more. Given this backdrop, the market is rightly cautious.

The market is nervous about future borrowing, and whether the Chancellor will be back at the dispatch box seeking more,

But what about shorter maturity gilts, which are more exposed to interest rate moves rather than overall borrowing and debt sustainability? The initial market reaction has seen gilt yields rise, predominantly on the back of higher forecasted inflation. There is a risk that the combination of an increase in the national living wage, additional national insurance contributions by employers, and previously announced labour market reforms, will place upward pressure on inflation. The OBR forecasts that inflation will be 2.5% next year and remain above the BoE’s Bank of England’s CPI target of 2.0% for the remainder of the forecast period. The BoE also raised its expectations for inflation at the 7 November MPC meeting. But much of the outcome here relies on the behaviour of firms and consumers.

It is unlikely the UK will enter a recession anytime soon, in part because the rise in government spending is so large. But there is a very real risk that the private sector enters into a recession as businesses reduce investment, slow the pace of wage rises, and delay hiring intentions in order to fund the rising costs of government fiscal policy. Should this happen then the BoE will need to react by lowering interest rates. One other unknown is the impact of in the US economic policy. If President-elect Trump were to impose tariffs on the scale suggested during his campaign, that could weigh on growth, particularly in Europe.

So with the UK base rate now at 4.75%, and five-year gilt yields around 4.3%, there is little priced into bond markets for the risk that UK growth starts to disappoint to the downside, particularly in the private sector. The recent weakness in fixed income markets following the UK Budget and the US elections has provided opportunities to add duration at attractive levels once again. We’ve looked to take advantage of this in gilt portfolios by adding duration, primarily in shorter maturity bonds, but also in 30-year maturity bonds which briefly reached 5.0%.

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