...this could have big implications for our AUD and our economy.
...it puts the RBA in the corner about cutting rates, cognisance of the interest rate differential with the US. If the US is only a larger cutting path ahead, it would have been easier for the RBA to cut. Now Higher for Longer rates is back, RBA would be on the backfoot....and that could be painful for our economy.
...Higher for Longer also means cash remains good with the high yield they provide, which means less money for equities. So that cuts risk : reward further for equities going forwards. The Fed just killed the Santa rally
Jerome Powell gave investors a rate cut. But what sent Wall Street plunging was his message for 2025.
Dec 19, 2024 – 9.13am
’Twas the week before Christmas, and all over Wall Street,
The traders heard the Fed, and voted with their feet.
Poor old Jerome Powell. The chairman of the US Federal Reserve must have thought he had a pretty good message to deliver to investors at his traditional post-meeting press conference.
The Fed’s financial projections for 2025 suggest the US economy is stronger than hoped, with economic growth forecasts pushed higher and unemployment predictions pushed lower.
But despite those healthy economic forecasts, despite inflation moving sideways for 2024, despite surging equity markets, despite the prospect of Donald Trump arriving next month with a swag of inflationary policies, and despite speculative asset classes like cryptocurrency surging, Powell still finished the year by delivering the 0.25 per cent rate cut, taking America’s official interest rate to between 4.25 per cent and 4.50 per cent.
But if Powell thought the market would greet him with applause, he was dead wrong.
Just two hours after announcing his rate reduction, Powell had been recast as The Grinch, with the S&P 500 sliding almost 3 per cent from its intraday high, and bond yields jumping higher. The benchmark 10-year US Treasury yield, which fell to 3.6 per cent in September, climbed about 6 basis points to 4.5 per cent.
So what spooked the market? Good news, of course.
The strength the Fed sees in the US economy heading into 2025 has led to a big adjustment in the famous dot plot of interest rate projections. Where the Fed previously saw four more 0.25 percentage point cuts in 2025, it now only sees two.
And the market doesn’t even really believe that – it’s now pricing in just one cut next June, and is clearly a little spooked by the idea that higher for longer is back.
Frankly, this all seems a little emotional and irrational when you zoom out. Powell and the Fed appear to have done a pretty good job in delivering a big reduction in inflation without the nasty spike in unemployment or the recession many thought was inevitable.
They’ve reacted to signs of weakness in the labour market with 1 percentage point of rate cuts during 2024, and now, with the economy in a better place than anyone expected a few months ago, they’re acknowledging the high level of uncertainty about what comes next – including Trump’s policy agenda – by signalling that they’ll be more cautious about providing further support to the US economy.
As Powell says, it’s like when driving on a foggy night, or walking into a dark room full of furniture: if you’re not sure, you slow down a bit.
If anything, it’s arguably surprising the Fed has cut as hard and fast as it has, given Powell happily conceded on Wednesday night that inflation might not get back to the US central bank’s 2 per cent target for another two years.
But none of that matters – what matters is how investors are positioned. Retail investors are as bullish as they’ve been. Bank of America’s fund manager survey released this week suggests fund managers are in a similar spot, with a record-low allocation to cash and a record-high allocation to US stocks.
As BofA’s Michael Hartnett says, sharemarkets are priced only for good news – for Trump to unleash animal spirits across the economy, for those all-conquering technology stocks to keep running, for global earnings to shoot higher, and for a compliant Fed to keep cutting rates.
But now a seed of doubt has been placed in the minds of investors. Will Powell keep up his end of the bargain?
The moves on Wednesday night are violent and, with a week of trading before Christmas, hopes of a Santa rally have been snuffed out.
But let’s be honest. With the S&P 500 up almost 25 per cent in 2024 – its second straight year of a return above 20 per cent – the market can afford to take a little year-end breather.
It may even be that Santa gets off the canvas in the coming days. Goodness knows there will be plenty of investors willing to buy the dip, and irrational and emotional moves can often be reversed fairly quickly.
But if nothing else, Wednesday night is a reminder to investors that the world is far less certain than suggested by the thundering herd that has pushed equity markets to extremes.
The US labour market is strong, but there are some data points that are consistent with recessions. Trump is unpredictable, and his policies could unleash inflation and animal spirits. The artificial intelligence revolution is in its early stages. Equity markets are expensive and extremely concentrated.
Powell’s reality check might feel like coal in the stocking of investors, but caution may turn out to be a useful gift heading into 2025.
