Why Fed rate cuts matter for global markets

LONDON (Reuters) – When the Federal Reserve delivers a widely anticipated interest rate cut on Wednesday, its first in four years, the move will resonate far beyond the United States.

The size of a first move and the extent of overall easing remain open to debate, while the looming US election is another complicating factor for investors and global rate-setters looking for direction from the Fed and pinning their hopes on a poor economic landing.

“We don’t know yet what kind of cycle this will be — will it be like 1995 when there was only 75 bps of cuts or 2007-2008 when it was 500 bps,” said Kenneth Broux, head of corporate research. , FX and rates at Societe Generale.

Here’s a look at what’s in focus in global markets:

1/ FOLLOW THE LEADER

In the spring, as U.S. inflation proved more persistent than expected, investors wondered how much others, such as the European Central Bank or the Bank of Canada, might cut rates if the Fed stayed on hold this year ahead for their currencies to weaken too much, adding to price pressures.

The US is finally cutting back, starting with comforting regions facing weaker economies than the United States.

Traders added to bets on rate cuts by other central banks as Fed rate cut expectations rose recently.

However, pricing less cuts in Europe than the Fed, ECB and Bank of England sounds more cautious about remaining inflation risks.

Confidence in the start of Fed tapering is a boon for bond markets globally, which often move in lockstep with Treasuries.

U.S., German and U.K. government bond yields are all set for their first quarterly decline since late 2023, when a Fed pivot was anticipated.

2/ BREATHING SPACE

Lower US rates could give emerging market central banks more room to relax and support domestic growth.

About half of a sample of 18 emerging markets tracked by Reuters have already started cutting rates this cycle, led by the Fed, easing efforts concentrated in Latin America and emerging Europe.

But volatility and uncertainty surrounding the US presidential election cloud the outlook.

“The US election will be a major influence on this because depending on the different fiscal policies, it really complicates the cut cycle,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas. “We could see more idiosyncratic actions among central banks based on that.”

3/ STRONG DOLLAR REPRIEVE?

Those economies hoping that U.S. interest rate cuts will further weaken the robust dollar, lifting their currencies, may be disappointed.

JPMorgan notes that the dollar has strengthened after a first Fed rate cut in three of the past four cycles.

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The dollar’s outlook will be largely determined by where US rates stand relative to others.

The safe-haven yen and Swiss franc could see their respective US rate cuts halve by the end of 2025, Reuters polls suggest, while the pound and Australian dollar could only gain a marginal yield advantage against the greenback.

Unless the dollar becomes a true low yielder, it will continue to hold its appeal among non-US investors.

Meanwhile, Asian economies led markets ahead of the US cuts, with South Korea gaining, the Thai baht and Malaysian ringgit rising in July and August. China’s yuan has erased year-to-date losses against the greenback.

4/ RALLY ON

A global equity rally, which has recently faltered on growth fears, could resume if lower U.S. rates boost economic activity and stave off recession.

Global stocks fell more than 6 percent in three days in early August after weak U.S. jobs data.

“You always have a jittery market around the first cut because the market is wondering why central banks are cutting,” said Emmanuel Cau, head of European equity strategy at Barclays.

“If you have a tapering without a recession, which is the mid-cycle scenario, usually the markets tend to come back,” Cau said, adding that the bank favored sectors that benefit from lower rates, such as real estate and utilities.

A soft US landing should also play well in Asia, although the Nikkei is down more than 10% from its July record high on a stronger yen and rising Japanese rates.

5/ TIME TO SHINE

On the commodities side, precious and base metals such as copper should benefit from the Fed’s rate cuts, and for the latter the demand outlook and a soft landing are key.

Lower rates and a weaker dollar, reducing not only the opportunity cost of holding the metals but also of buying them for those using other currencies, could fuel the momentum.

“High rates have been a headwind for base metals, leading to a significant negative physical demand distortion due to destocking and weighing on capital-intensive final demand segments,” said MUFG’s Ehsan Khoman.

Precious metals could also gain. Gold, which typically has a negative relationship with yields because most of the demand is for investment purposes, typically outperforms other metals during rate cuts. It’s at record levels, but investors should be cautious, said John Reade of the World Gold Council.

“Speculators in the Comex gold futures markets are positioned for this,” said market strategist Reade. “It could be a case of buying the rumor and selling the fact.”

(Reporting by Karin Strohecker, Samuel Indyk, Amanda Cooper and Eric Onstad in London, Yoruk Bahceli in Amsterdam and Tom Westbrook in Singapore; Graphics by Sumanta Sen, Editing by Dhara Ranasinghe and Alex Richardson)