— George Herbert
“Gold is the universal language understood by all nations.”
There is no doubt what was the biggest market news this month. After 11 rate hikes followed by a year in a holding pattern with rates at decadal highs, the Fed finally cut. And they did so with an emphatic -50bp trim – effectively a double cut. This came as some surprise (markets had been split on the outcome, which the Fed did not telegraph in advance) and the tussle was apparently real within the Committee itself, with a first dissenting vote since 2005.
After 11 rate hikes followed by a year in a holding pattern with rates at decadal highs, the Fed finally cut.
But Fed Chair Powell was explicit that inflation was not yet beaten and reiterated that future decisions would be data-driven. With markets still more dovish than the Fed’s dot plot, we expect similar dynamics at the next meetings – but see no urgency in the macroeconomic data to back another 50bp cut in November. We retain our view that the cutting cycle need not be as precipitous as the hikes were steep. But the direction of travel is clearly downwards and there is a high degree of uncertainty in any medium-term forecast.
The start of a rate-cutting cycle nonetheless raises new possibilities for investors.
Historically, rate cuts have boosted fixed income returns. The US curve has steepened – disinverting for the first time since March 2022 – as front-end rates decline. Curve normalisation and a clear downward path for rates point to positioning further out along the curve, especially for investors keen to lock in higher yields while they can (while also benefiting from price appreciation as rates fall).
Lower rates are generally positive for stocks too – something not lost on markets that have fizzed since the cut (the S&P 500 closed at a record high the day after, before minting another three records last week). Lower rates stimulate the real economy, boosting top lines. They ease companies’ debt burdens and spur borrowing and investment (witness the rush to issue since the Fed cut). The positives are felt particularly among high-growth companies; as such, the techy NASDAQ has outpaced the wider market since the cut. Weighing against this positive outlook is the fact that S&P 500 performance has already been unusually strong in the months before this first cut, compared to previous cycles. We thus remain wary of already-generous valuations. That said, the rising index-level tide did not lift all boats equally over the last year, and segments knocked back by the tightening cycle – including utilities, renewable energy and small caps – now have room to rebound.
The macroeconomic context for cuts will be crucial for asset performance: will the Fed be fighting an ailing economy, or is Captain Powell gliding us into a soft landing? Data from past cycles are clear: risk assets will struggle if there is a recession in the next 12 months, regardless of cuts. For now, the US data remain finely poised but a soft landing is still in play. The PCE Index – the Fed’s preferred inflation gauge – fell more than expected (to 2.2% YoY) and Powell was adamant that ‘the US economy is in a good place’. We see some signs of cooling – labour market prints and consumer sentiment have softened – but with the Atlanta Fed’s GDPNow reading +2.9%, it is hard to see an imminent recession.
For now, the US data remain finely poised but a soft landing is still in play.
The picture is less rosy in Europe. In the month where a major report from former European Central Bank (ECB) president Draghi detailed the European economy’s long-term weaknesses, data releases have underscored the weakness on the immediate horizon. The major northern economies in particular are struggling, led by Germany, where business and consumer sentiment reached new lows in September. The Eurozone composite PMI points to contraction, with France (47.4) and Germany (47.2) both well below 50. In France, an ugly fiscal outlook and political uncertainty add to the pressure: this month a government was finally formed but, with no parliamentary majority, it will struggle to pass a budget. Strikingly, French OAT 10Y yields last week moved higher than their Greek equivalents.
Against this backdrop, we expect the ECB to cut again in October, keeping the Eurozone on a trajectory towards lower rates and a weaker Euro.
Meanwhile, Chinese equity investors who for months have clamoured for Beijing to pull out all the stops to get the economy revving again – and revive the country’s stock markets – finally got some relief, with the biggest stimulus package since the pandemic. The central bank cut multiple policy rates, boosted bank liquidity, cut mortgage rates – and guided towards more easing. It also announced $114bn to support stock purchases. The Politburo added to the momentum when it pledged more fiscal stimulus – a sizeable shift in stance.
This was music to markets’ ears and mainland Chinese stocks notched their best week since 2008 (CSI 300 +15.7%) – while Hong Kong’s Hang Seng enjoyed its biggest weekly gain since 1998 (+13.0%). We have pointed for some time to the tactical opportunity from a Chinese equity rebound and so welcome these policy moves. But we would question whether Xi has pulled out all the stops: there is no detail yet on the promised fiscal stimulus, and meaty action is still needed to pull the domestic economy out of the doldrums.
We have pointed for some time to the tactical opportunity from a Chinese equity rebound and so welcome these policy moves.
The US rate cut was rightly a major focus in September – and if the unlikely couple of Jerome Powell and Xi Jinping can simultaneously pull off a US soft landing and a Chinese recovery, the outlook for a host of assets is bright. But investors should not get ahead of themselves. Risk events pushed down the agenda in September will reassert themselves in October – chief among them the US election. This hangs in the balance, with real risks to the US fiscal position, global trade and geopolitics. Equity volatility is likely to ratchet up. The worsening geopolitical situation in the Middle East should also give investors pause.
These risks, on top of falling rates, underscore our leaning to gold, which has served us well this year and looks to sustain momentum as it continues through nominal all-time-highs. The trend of macroeconomic divergence is continuing (with different regions at different points in the cycle), creating a diversity of opportunities for investors, and we continue to like alternative strategies structured to exploit these.
For now, after four straight years of September equity market falls – and seven for fixed income – we are glad this September has finally snapped that negative run.
If you have any questions about the themes discussed in this article, please do not hesitate to get in contact with us: info@bedrockgroup.ch
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