Asset Allocation Observatory: Disappearing cuts 

There were two familiar areas of attention this week – monetary policy and geopolitics. On the monetary policy side, Fed Chair Powell dampened expectations of an imminent cut in US interest rates – highlighting the slower-than-expected progress on inflation in the face of a pretty healthy US economy. The market reacted, with the 10-year yield rising again. Futures earlier this week priced in only one rate cut this year in the US, down from as many as seven at the end of 2023. That’s a pretty sharp change in view.

Powell’s comments also raised questions again about just why the US economy has proven quite so resilient. We’ve seen a couple of arguments put forward, but we think they’re probably related. The first (as quoted in Bloomberg) is that higher rates mean that households are getting a return on their cash for the first time in years, and they’re spending it to support the economy. That’s not the usual macroeconomic argument – which says that higher rates should slow the economy. The second argument (from the IMF’s semi-annual economic outlook) is that government spending (and tax incentives) in the US is driving growth and it’s not sustainable. The US government has a different perspective, as you might imagine, but it seems clear that we won’t see a shift in fiscal policy ahead of the election. 

One way or another, households with savings are getting a better return than they were and maybe there are enough of them to drive domestic demand. In the US, it also helps if you were able to lock in a low mortgage rate for the next thirty years – something that’s not really available in the UK. 

The situation in the Eurozone is a little different. Growth has been weaker, and inflation has moved closer to target. We think that the ECB is well-placed to lower its policy rate ahead of the US. The UK sits somewhere in the middle—growth remains anaemic while inflation, according to the latest release, is still above where the Bank of England would like. But we’d argue that the case for a rate cut in the UK remains stronger in the short term than in the US. 

The second topic is around geopolitics and the ongoing conflict in the Middle East. As we’ve noted before, financial markets have often looked past periods of geopolitical uncertainty, but the prospect of a widening of the current conflict has raised concerns. From a financial markets perspective, there are a couple of sources of impact. The first is really market sentiment – investors sell risky assets and buy so-called “safe haven”, be they government bonds, gold, or something else. This sentiment can shift quickly, in either direction. The second is on the macro impact – with the potential risk of slower growth and higher inflation, really driven by a combination of sentiment and supply chain pressures. The current situation remains very uncertain, but it’s too soon to conclude that there’ll be a long-term impact on the global economy. 

Where does this leave us? Geopolitics is complicating the short-term outlook, and that’s weighed a bit on market sentiment over the past few days. It adds, at least a little bit, to the policy challenges that Central Banks continue to face – as they try to divine the outlook for inflation and growth. Overall, we think the case for lowering policy rates looks stronger in Europe than it does in the US, where growth remains strong, and that could improve the outlook for global growth later in 2024 and into next year.

Richard Flax: Richard is the Chief Investment Officer at Moneyfarm. He joined the company in 2016. He is responsible for all aspects of portfolio management and portfolio construction. Prior to joining Moneyfarm, Richard worked in London as an equity analyst and portfolio manager at PIMCO and Goldman Sachs Asset Management, and as a fixed-income analyst at Fleming Asset Management. Richard began his career in finance in the mid-1990s in the global economics team at Morgan Stanley in New York. He has a BA from Cambridge University in History, an MA from Johns Hopkins University in International Relations and Economics, and an MBA from Columbia University Graduate School of Business. He is a CFA charterholder.