Transcript
Speaker: Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Speaker: This podcast was recorded for publication on the 19th of September, 2024 by HSBC Global Research.
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Speaker: Hello, I'm Aline Van Dyne in New York and welcome to the Macro Brief.
Speaker: It's a moment we have all been talking about for many months, the start of the Federal Reserve's easing cycle.
Speaker: Well, it's here and after much speculation about the size of the rate cut, in the end, policymakers opted for a chunky 50 basis point reduction.
Speaker: On today's podcast, we're looking at the state of the U.S. economy, what's next for U.S. interest rates, and what the start of the easing cycle means for global equity markets.
Speaker: And to discuss all this, I'm joined in the studio by Ryan Wang, U.S. economist, and Alistair Pinder, head of EM and global equity strategy.
Speaker: So Ryan, let's start with a quick recap of why the FOMC went for a 50 basis point cut rather than a more conventional 25 basis points.
Speaker: Indeed, this was a long-awaited Fed decision, and we did get the larger rate cut, the 50 basis point size.
Speaker: I think if you put it most straightforwardly, and this is what we heard from Fed Chair Jerome Powell in the press conference, in a way the rate cut reflects greater confidence that inflation has moved lower, that it is moving at least closer to 2%.
Speaker: And in turn, what the decision shows is a shift a little bit away from the elevated inflation of the past two years and more to what's been going on in the labor market.
Speaker: Chair Powell said that by many metrics, including the unemployment rate, actually, the labor market may be a little bit less tight today than it was all the way back in 2019 before the pandemic.
Speaker: We have seen that hiring is still continuing, but at a pace that's much slower than it has been in previous years.
Speaker: And so I think those are really the key drivers that help the Fed make its decision.
Speaker: In terms of then what it says about the state of the US economy, Ryan, is this bigger cut, 50 basis point cut, signal confidence in economic resilience or is it concerns about economic weakness?
Speaker: Where would you fall on that side of the debate?
Speaker: Well, I think it is a little bit of a nuanced picture.
Speaker: I mean, I think what we do see in the data and Chair Powell did emphasize these themes is that the cooling in the labor market has mostly been on the hiring side, slower rates of hiring rather than a marked acceleration in layoffs.
Speaker: And businesses also generally are not reporting that they're thinking about big time reductions in the size of their workforces.
Speaker: And so what it appears is that the U.S. economy is still growing and it doesn't really appear that there are imminent signs of recession.
Speaker: But at the same time, the Fed, of course, doesn't necessarily want to wait for those signals to emerge before delivering that first rate cut.
Speaker: And because the policy rate is so high still, still even after the latest decision almost at 5 percent on the policy interest rate, that's more or less why the Fed decided to make a bigger move at the beginning to try to bring rates down to closer at least to what might be considered neutral for the economy and no longer as restrictive as has been the case over the past couple of years.
Speaker: Thanks, Ryan.
Speaker: And of course, you already mentioned the inflation picture earlier.
Speaker: But before we get into what's next for rates, let's bring in Alistair.
Speaker: How have financial markets reacted to the move?
Speaker: Positively, if you look at S&P futures and in the Nasdaq futures, specifically, you know, the equity markets up almost 2%.
Speaker: So it's quite a big rally.
Speaker: And that's been broad based around global equity markets.
Speaker: So Europe has also responded very positively to this, you know, clearly, the markets are signaling that, you know, lower Fed rates should, you know, move into lower bond yields.
Speaker: And that typically is supported for valuations, particularly in
Speaker: if you don't become overly concerned about the economic backdrop.
Speaker: Right.
Speaker: So the interpretation has been more towards economic resilience rather than this is a sign of serious problems.
Speaker: Exactly.
Speaker: And I think one of the interesting things, you know, if you look at equity markets and their performance historically around Fed cuts, you know, what matters is this economic backdrop.
Speaker: The policy easing alone is not that important for equity markets.
Speaker: So to give an example of this, if you look at the performance of the S&P 500 around Fed easing cycles going back to 1965, actually the divergence has depended on one thing.
Speaker: Is the U.S. economy heading into a recession or not?
Speaker: And if it isn't, then equity markets have typically rallied 10% in the following six months.
Speaker: But if that U.S. economy is sharply slowing down, then equity markets are down around 12%.
Speaker: And are there any other historical lessons in terms of what are drivers of the equity markets when an easing cycle kicks in?
Speaker: Well, I think, you know, one of the other key takeaways is just, you know, sector performance and what happens from that perspective.
Speaker: I think there is definitely a perception that maybe cyclicals could do quite well in this current backdrop.
Speaker: But again, looking back historically, there's the message has been quite straightforward.
Speaker: Actually, defensives typically outperform cyclicals.
Speaker: And there's two reasons for this.
Speaker: One is that lower interest rates
Speaker: typically supports their valuations, particularly for some of these long duration sectors.
Speaker: The other aspect to this is that recession or not, the reason why the Fed is easing is because as Ryan mentioned, the economy is slowing.
Speaker: And if that is the case, then typically, defensives perform best in that environment.
Speaker: Thanks, Alistair.
Speaker: So let's switch from kind of the past to the future.
Speaker: Ryan, what can we expect next in terms of US policy rates?
Speaker: Well, I'll start first with our new forecast for Fed rates.
Speaker: We expect that after the 50 base point rate cut delivered in September that the Fed will follow up with 25 base point rate cuts at each of the next six scheduled Fed meetings.
Speaker: So those are the two remaining this year in November and December and then the first four meetings of 2025.
Speaker: And so that would take the federal funds target range from its current four and three quarters to five percent.
Speaker: down to three and a quarter to three and a half percent by the middle of next year.
Speaker: And what are you expecting in terms of the economic picture into 2025?
Speaker: Well, this is really interesting because it partly relates to this debate that I think we can see is unfolding at the Fed with respect to how quickly to reduce that policy rate.
Speaker: Of course, it does have to do a lot with how the economy actually evolves into next year.
Speaker: In particular, I think what I've tried to explain so far is that the initial steps may be more policy normalization, trying to bring rates down to a less restrictive level and not necessarily reacting to imminent signs of economic weakness.
Speaker: So as we go into next year, we'll be keeping a close eye on the monthly job numbers.
Speaker: They have averaged approximately 160,000 per month over the past year once you make some adjustments.
Speaker: So that's still positive jobs growth.
Speaker: But if you slow significantly below that level, well, I think that would be a catalyst for the Fed to become more concerned and the markets as well.
Speaker: If I can just jump in and ask you a question, Ryan, you know, when the Fed started the the hiking cycle, you know, back in 2022, the one of the interesting aspects was that there was always discussion about the lag effects.
Speaker: And because you know, some of the debt composition had changed, and maybe the impact on the real economy wasn't going to materialize as quickly as we had seen in previous cycles.
Speaker: So what does this mean in terms of, you know, when the Fed starts cutting interest rates?
Speaker: Do you think it's going to have as big of an impact on the economy as we've seen previously?
Speaker: Well, I think this is an extremely interesting question.
Speaker: And what I would say is that when you talk about rate hikes and then rate cuts on the way down, the impact is different depending on whether you're talking about the shorter end of interest rates or the longer end.
Speaker: And of course, we know in the US, for example, that long rates have a big effect on the housing market.
Speaker: But the short end, you know, that matters as well for borrowers, whether it's households that are borrowing through the consumer channels or smaller businesses or even if we talk about commercial real estate projects that need financing.
Speaker: Well, in each of these instances, oftentimes the short rate can matter quite a lot.
Speaker: And that's part of the reason why this decision about 25 versus 50 base points at a particular meeting, it's not theoretical.
Speaker: It's a very practical decision that makes a difference for all those types of borrowers.
Speaker: So on those borrowers, Ryan, any comments or just a summary of the state of the U.S. consumer?
Speaker: How resilient is that part of the economic picture?
Speaker: I think what you see in the U.S. is still very much a divergence.
Speaker: The aggregate numbers are holding up pretty well, but I think you do see signs, growing signs really, of financial stress for many households, particularly lower-income households that are struggling with the high price level from basic necessities like groceries.
Speaker: I think that is coming through in the data, and also businesses are reporting that their consumers are becoming more price sensitive, less able to absorb these big price increases of recent years, and that's
Speaker: Another sign that as we go into the year ahead, yes, growth is likely to continue to slow.
Speaker: And the question is whether it slows in a fashion that would really signify an economic downturn.
Speaker: And of course, a discussion for another day, but it would be remiss not to mention that the U.S. election could have an impact on all these things.
Speaker: Just a quick mention, what are the main policy areas that you would be looking out for?
Speaker: Yeah, it certainly is going to be topical.
Speaker: Just to mention it, the next Fed meeting actually occurs a few days after the November election.
Speaker: And so, you know, when we think about the perspective size of the next rate cut, for example, of course, that's something else to consider.
Speaker: It'll be right after the election outcome.
Speaker: Now, as we look into next year, there are several policy areas that clearly could impact both the path of the economy and therefore the prospective path of Fed easing.
Speaker: Those could include things like tax policy, tariffs, immigration policy also, and changes in immigration have had a big effect on the U.S. economy over recent years.
Speaker: So those are just three very important policy areas where the election results could matter greatly.
Speaker: I think, you know, the big areas are going to be on trade and tariff policy.
Speaker: And, you know, as Ryan mentioned, corporate tax in the US, I think that's going to have the biggest impact on regional divergences of equity markets across the globe.
Speaker: Thank you both so much.
Speaker: Look forward to further updates as we see what unfolds in the US.
Speaker: Thanks very much.
Speaker: Now, before we go, here's your last call for the next edition of our Live Insight series.
Speaker: On the 25th of September, we'll be looking at the latest evidence of physical climate impacts across G20 countries.
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Speaker: So that wraps things up for today.
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