What do US interest rate cuts mean for the economy and election?https://en.majalla.com/node/322295/business-economy/what-do-us-interest-rate-cuts-mean-economy-and-election
What do US interest rate cuts mean for the economy and election?
Donald Trump will not be happy but Kamala Harris could benefit from this week’s decision along with borrowers, consumers, and investors
Eduardo Ramon
The decision to cut interest rates not by 0.25% but by 0.5% lets industry and money markets breathe a sigh of relief after two years of stress and turmoil.
What do US interest rate cuts mean for the economy and election?
Finally, the US Federal Reserve and its chairman, Jerome Powell, have reached the moment that the business and financial worlds have been waiting for. The decision to cut interest rates not by 0.25% but by 0.5% lets industry and money markets breathe a sigh of relief after two years of stress and turmoil.
Interest rates had been raised to their highest levels in nearly 25 years with the aim of cutting inflation, which soared after Russia invaded Ukraine in February 2022. This had weighed heavily on economies around the world, not least on oil and metal prices, banks, stock markets, real estate, and tech companies.
Former US President and Republican presidential candidate Donald Trump, eyeing the election in November, will not be happy with Powell’s decision, given that it boosts the incumbent administration—represented by Democratic candidate Kamala Harris.
Polls will show whether and how this decision affects Harris's popularity, who is currently Vice President. A recent poll by Ipsos and ABC News showed that 46% of voters trust Trump on the economy, compared to only 39% for Harris.
From Fed independence
With just weeks to go before the 5 November vote, Harris needed some good economic news and will be thankful for this timely monetary and financial boost, despite her having opposed Powell’s reappointment she was senator. She will also thank US President Joe Biden for supporting the independence of the central bank in setting and adhering to monetary policies, the wisdom of which was recently summarised by Powell.
The decision to cut interest rates not by 0.25% but by 0.5% lets industry and money markets breathe a sigh of relief after two years of stress and turmoil.
"The reason is that, over time, people realised that insulating the central bank from direct political control prevents the manipulation of monetary policy to serve political leaders rather than the public's broader interest," he said.
It is unclear whether the Fed's sharp start to its easing cycle will restore the confidence of investors. Some are wary of a Trump presidency and have sought refuge in gold, which soared to an all-time high following the Fed's decision, reaching just over $2,592 per ounce, while US gold futures climbed 0.2% to just over $2,598.
Meanwhile, the yield on two-year US Treasury bonds fell to 3.6%, and the yield on 10-year bonds dropped to 3.68%. In oil, Brent crude futures for November dropped to $73.65 per barrel, while US crude futures for October fell to $70.91. Earlier, oil prices climbed after hundreds of devices exploded in Lebanon. With Israel targeting the communications of senior Hezbollah figures, the markets began to price-in the possibility of an escalation.
Piloting a soft landing
The Fed's half-point cut in interest rates followed a period of ten consecutive increases since March 2022. Almost everyone felt the time had come to cut, with the 12 regional Fed bank presidents voting 11-1 to descend from 5.25-5.50% to 4.75-5.00%.
Some monetary policymakers believe that the benchmark interest rate will be reduced by another half-point by the end of this year, a full percentage point in 2025, then another half-point in 2026, ultimately settling around 2.75-3.00%. This would represent the much-vaunted "soft landing".
Traders on the New York Stock Exchange, August 23, 2024.
This week's decision should be a relief not just to Harris but to borrowers, companies, and investors. It will also help to avoid, or at least delay, a recession in the US, depending on the outcome of the upcoming US presidential election and its subsequent impact.
Steady monetary easing and lower borrowing costs would represent a response to growing concerns about the stability of labour markets and jobs.
Next to its counterparts, such as the European Central Bank (ECB) and the Bank of England (BoE), the Fed has been seen as cautious, but all central banks are wary of latent risks that could reignite inflation. Powell has stood by the data and stood above momentary market panics, such as occurred in early August. He has also appeared impervious to the influence of rate cuts by other central banks. Hours after the Fed cut, the BoE left rates at 5% after news that UK inflation levels remained stuck at 2.2%.
Two eyes on inflation
Inflation in the US has dropped to 2.5% from more than 7% two years ago. This is close to the Fed's 2% target. The Fed's monetary policy committee said it "has gained more confidence that inflation is moving sustainably towards 2%, and estimates that the risks to achieving employment and inflation goals are nearly balanced".
The sharp decline in inflation and persistently high interest rates would have cast doubt on the timing and scale of future cuts. "We don't yet know what kind of cycle this will be," said Kenneth Brooks at Société Générale. "Will it be like 1995, with just a 75-basis point reduction, or like 2007-08, when there was a 500-basis point cut?"
The US economy was on the verge of exiting a major recession in 1994, leading to drastic increases in interest rates, as well as in 2007-08, following the debt and mortgage crises that plunged the country into another severe recession.
Home mortgage rates are posted outside a real estate office shortly before the Federal Reserve interest rates announcement on September 18, 2024 in Los Angeles, California.
As such, there is concern that the Fed's decision—the first step in a gradual interest rate reduction process—may not yield the desired effects as quickly as hoped and may not prevent the US from entering a full-scale recession.
While some investors are waiting, others think the rate cut came too late. Yet there is no doubt that the Fed's decision reflects its confidence in the overall economic climate. This should give investors a boost.
The cut aims to create a positive shock that revitalises markets on the one hand while establishing a stable and comfortable environment on the other. Yet the real impact of the Fed's decision remains to be seen.
Likewise, the next White House resident is still to be decided. Whoever it is, they may preside over a recession despite this week's cut. That will be of interest to many, given that the old maxim—that if the US economy sneezes, the rest of the world catches a cold—remains true for now.
