Why Fed Rate Cuts Matter for Global Markets

LONDON (Reuters) – When the U.S. Federal Reserve cuts interest rates in a widely expected move on Wednesday, its first rate cut in four years, the move will resonate beyond the United States.

The size of the first step and the overall scale of easing remain open to debate, while the looming US election poses another complicating factor for global investors and rate-setters looking for guidance from the Fed and pinning hopes on a soft economic landing.

“We don’t know yet what kind of cycle it will be — whether it will be like 1995 when there were only 75 basis point cuts or 2007-08 when there were 500 basis point cuts,” said Kenneth Brooks, head of corporate, foreign exchange and rates research at Societe Generale.

Here’s a look at what’s in focus in global markets:

1/ Follow the leader

In the spring, as U.S. inflation proved more persistent than expected, investors wondered how much other banks like the European Central Bank or the Bank of Canada would be able to cut interest rates if the Fed stayed on hold this year before their currencies weakened too much, adding to price pressures.

The US cuts are finally starting to bring relief to regions with weaker economies than the US.

Traders added to bets on interest rate cuts by other central banks as expectations of a rate cut by the Federal Reserve have grown recently.

But they price in less interest rate cuts in Europe than they expect from the US Federal Reserve, with the European Central Bank and the Bank of England appearing more vigilant about lingering inflation risks.

Confidence that the Federal Reserve will start cutting interest rates is a boon for global bond markets, which often move in lockstep with Treasuries.

U.S., German and British government bond yields are expected to post their first quarterly declines since the end of 2023, when a shift in Federal Reserve policy was expected.

2/ Space to breathe

Lower interest rates in the US could give emerging market central banks more room to maneuver to ease pressures and support domestic growth.

About half of the sample of 18 emerging markets tracked by Reuters have already started cutting interest rates this cycle, ahead of the Fed, with easing efforts focused on Latin America and emerging Europe.

But the volatility and uncertainty surrounding the US presidential election cast a shadow over the outlook.

“The US election will have a big impact on this, as it will complicate the rate-cutting cycle, depending on different monetary policies,” said Trang Nguyen, head of global emerging markets credit strategy at BNP Paribas. “We may see more unconventional actions among central banks on the back of that.”

3/ Will the strong dollar return?

Those economies that hope that U.S. interest rate cuts will further weaken the strong dollar, boosting the value of their currencies, may be disappointed.

JPMorgan noted that the dollar strengthened after the Federal Reserve’s first rate cut in three of the last four cycles.

The story continues

The future of the dollar will depend largely on US interest rates compared to other countries.

Reuters polls suggest that the safe-haven yen and Swiss franc could see their discount to U.S. interest rates halve by the end of 2025, while the British pound and Australian dollar could gain only a marginal yield advantage over the greenback.

If the dollar does not become a truly low-yielding currency, it will still retain its appeal among non-US investors.

Meanwhile, Asian economies have led markets ahead of the US rate cuts, with the South Korean won, Thai baht and Malaysian ringgit all rising in July and August, while the Chinese yuan erased its year-to-date losses against the US dollar.

4/ The gathering

Global stock markets could resume their rally, after recently faltering on growth concerns, if a U.S. interest rate cut boosts economic activity and averts a recession.

Global stock markets fell more than 6% in three days in early August after weak U.S. jobs data.

“There is always a volatile market at the first rate cut because the market wonders why central banks are cutting rates,” said Emmanuel Cau, head of European equity strategy at Barclays.

“If you have a rate cut without a recession, which is the mid-cycle scenario, markets tend to rally again,” Cao said, adding that the bank favors sectors that benefit from lower interest rates, such as real estate and utilities.

A soft landing in the US is also expected to be beneficial in Asia, although the Nikkei is down more than 10% from its record high in July as the yen strengthens and interest rates rise in Japan.

5/ It’s time to shine

In commodities, precious and base metals such as copper are expected to benefit from interest rate cuts by the Fed, and for base metals, demand expectations and a soft landing are the main factors.

Lower interest rates and a weaker dollar, which would reduce not only the opportunity cost of holding the metal but also of buying it for those using other currencies, would fuel momentum.

“Higher interest rates have been a critical headwind for base metals, distorting negative physical demand significantly due to inventory drawdowns and pressure on capital-intensive final demand sectors,” said Ehsan Khoman of Mitsubishi UFJ Bank.

Precious metals could also gain. Gold, which is typically negatively correlated with yields because it is in demand for investment purposes, typically outperforms other metals during interest rate cuts. Gold has hit record highs, but investors should be cautious, said John Reed of the World Gold Council.

“Comex gold futures traders are preparing for this,” said Reed, a market strategist. “It could be a case of buying the rumor and selling the truth.”

(Reporting by Karen Strohecker, Samuel Indyk, Amanda Cooper and Erik Onstad in London, Yoruk Bahceli in Amsterdam and Tom Westbrook in Singapore; Graphics: Sumanta Sen; Editing by Dara Ranasinghe and Alex Richardson)