Analysis-Global investors brace for turmoil as big Fed cut creates confusion By Reuters

By Naomi Rovnick and Yoruk Bahceli

LONDON (Reuters) – Major global investors are on alert for wild market swings after a huge U.S. interest rate cut sparked confusion over whether the world’s dominant economy will boom or face recession , confusing the outlook for stocks, bonds and currencies worldwide.

Global shares hit record highs on Thursday, a day after the Federal Reserve cut borrowing costs by 50 basis points from a 23-year high, while the euro, sterling and currencies from Norway to Australia strengthened against the dollar. US stocks rose after a muted initial reaction to Fed tapering.

But in a sign that Fed tapering is making policymakers outside the US nervous, the Bank of England kept interest rates steady on Thursday, citing uncertainty about inflation and global demand.

Traders scrapped their forecasts for a UK rate cut, and some money managers warned the Fed could add too much support to an already robust US economy, lifting global growth but potentially also commodity and consumer goods prices.

“I think it’s more likely that the Fed will taper too much and the economy will accelerate,” said Trevor Greetham, head of multi-assets at Royal London.

“There may not be a lot of (global) rate cuts then,” he said, adding that he expected more market volatility here.

“I see more turbulence, there’s too much risk,” chief economist Tim Drayson said, citing the outlook that the U.S. would slow.

LGIM, Britain’s biggest asset manager, has not yet taken strong positions in global stocks and bonds, he said.

DIVERGENCE?

Traders see the Fed funds rate falling 72 bps this year and 195 bps by October 2025.

They cut near-unanimous bets on a quarter-point cut in UK interest rates in November to around 80% and see the European Central Bank as unlikely to cut rates next month, but investors saw such predictions as unstable.

These European rate-setters face slower growth than the US, but tighter inflation. Their political paths and markets depend on a range of unpredictable scenarios for the US economy.

Fidelity International portfolio manager Shamil Gohil said weakened growth in the US and UK could persuade the BoE to cut rates faster and boost British government bonds, known as gilts.

But such positions were vulnerable to current expectations for further cuts in US interest rates turning out to be wrong, he said.

“This could be a scenario where all markets sell off,” he said, adding that global market volatility was generally expected to increase.

Gohil said his portfolio was defensive with a preference for investment grade corporate bonds.

Neil Mehta, portfolio manager at BlueBay Asset Management, warned that the Fed is entering a “very hot” economy with GDP growth at 3% and inflation still above target.

Core inflation in the euro zone is just below 3 percent and policymakers are divided over future interest rate cuts after it cut borrowing costs in June and September.

But if the Fed keeps going, additional euro strength against the dollar would put pressure on the ECB, making exports less competitive, Greetham said.

Marcus Jennings, Fixed Income Strategist at Schroders (LON: ) said a dovish Fed, coupled with a weak eurozone economy, did

German Bunds more attractive.

But investors warned that any global outlook for the central bank could change if US data changes views on what the Fed can do next.

“If you start to see a (US) labor contract, they (the Fed) would be much more aggressive,” said TS Lombard chief Dario Perkins. “Then they would start to panic a little bit about what was going on. If employment starts to come back, then that would suggest that policy is not as tight as they thought.”

The stock market’s implied volatility gauge fell to 16.6 on Thursday, well below a peak of nearly 66 during market turmoil in early August, due to a surprisingly weak US jobs report and currency market swings .

MSCI’s index of world shares has also gained more than 10 percent since that Aug. 5 jolt.

Sheldon MacDonald, Marlborough’s chief investment officer, said market volatility could rise as stock market assessments suggested the US economy would be boosted by rate cuts, but the price of government bonds suggested a recession.

Ben Gutteridge, multi-asset manager at Invesco, said if the Fed prevented a recession, it would boost trades focused on central bank divergence, such as bets that a tighter BoE would keep the pound stronger against the dollar.

But a U.S. recession would weaken stocks and support bonds around the world, reducing regional market divergence, he said.

“If you don’t want to lose money, you have to do the Fed right.”