At last, the Federal Reserve (the Fed) has joined the global easing cycle party. On Wednesday, after what has felt like one of the longest and most painful hiking cycles, the Fed announced a change to their target range and cut interest rates 0.50%, bringing the range to 4.75% - 5.0%.

Since first embarking on an aggressive rate hiking campaign in early 2022 to bring down inflation, Fed Chairman Jerome Powell has been clear that the focus for the Fed is to keep labor markets from seeing more softness, and markets appear to have finally heard the message. On the short end of the yield curve, markets are now pricing in another 200 basis points (bps) of easing over the next year. Further out on the curve, the 10-year remains lower than the Fed Funds rate, indicating the market is pricing in lower future growth and inflation expectations. Perhaps more importantly, it is viewed by many as a signal that monetary policy is overly restrictive.

Our Thoughts on the Fed Meeting

Chairman Powell highlighted that risks for inflation to surprise to the upside have diminished while downside risks to employment have moved higher. Governor Michelle Bowman dissented to the larger rate cut, the first opposition in over two years. While Chairman Powell emphasized that the Fed is not in a rush to move rates to the neutral level, the market has been quick to price in another 75 bps of cuts over the next two meetings.

We continue to think pricing in a trough Fed funds rate around the 3.0-3.5% level is consistent with fair value but that the market is ahead of itself in how quickly the Fed will be able to get there.

How the Fed Compares to Other Central Banks

Across the Atlantic, the European Central Bank (ECB) cut their policy rate by 25 bps in September for the second time this year. The ECB kept rates unchanged during the August meeting as services inflation remained sticky despite a prolonged draught in industrial economic activity. Compared to the U.S., markets are pricing in a much shallower rate cutting cycle in Europe for the previously mentioned reasons, however, we have somewhat of a different perspective. Given weakness in external demand for European products and a lower structural growth rate in Europe, we would be surprised if the ECB does not need to cut as much as the Fed.

Elsewhere in Europe, the Bank of England (BOE) has been hesitant to cut rates as much as we originally thought so far this year. Despite higher funding costs and already high home prices, housing activity remains robust. As such, markets see an even shallower cutting cycle in the U.K. than most G7 central banks, which has helped the pound appreciate significantly against the U.S. dollar over the past few quarters. All things considered, it would be a surprise to all if the BOE were to continue their hawkish rhetoric while most of the world has turned dovish.

Taking a look to our neighbors to the north, the Bank of Canada (BOC) has led the global easing cycle so far this year. In fact, the BoC has cut their policy rate by 75 bps over the past three meetings as the Canadian economy is flirting with recession, and core inflation is below 2%. On top of the easing that has already occurred, commentary from BoC members indicates the BoC is ready to implement 50 bps cuts moving forward should the economy continue on a decelerating path.

Now there always has to be that one person that goes against the grain, and in this case, it is Japan. After raising rates by a cumulative 35 bps so far this year, markets reacted harshly in August as investors unwound their Japanese yen carry trades. Essentially, speculators had been using the yen as a low yielding funding currency and closed out their short positions leading to widespread panic in global markets. While panic only lasted a short time, the impact has been lasting in terms of future expectations in JPY rates markets as the market only expects 20-25 bps of hikes over the next twelve months. Should the Bank of Japan continue to embark on tightening when the rest of the world is easing, we would expect to see continued volatility.

Our Final Thoughts

In summary, we see two paths for the global economy and markets from here. Central bankers are dreaming of a continued soft landing whereby growth remains buoyant, and inflation continues towards target. Certainly, risk markets are already there in terms of forward pricing. If that view is correct, markets are likely overestimating the number of cuts by global central banks for the next 6-12 months.

However, should the softness we are seeing in industrial data and elements of employment data turn to outright weakness and higher unemployment rates, the pricing of recession risk needs to reenter the calculus in risk markets (rates are already pricing in a healthy amount of recession risk). In our opinion, the convergence of optimism in risk markets and pessimism in rates markets will likely be the key theme over the next few quarters. As it evolves, our active management fundamentals and processes remain at the forefront of our decision making.

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Source: Wall Street Journal.
This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.