In terms of expectations over the size of the Federal Reserve’s anticipated first rate cut in more than four years, I think the data was always between 25 and 50 basis points (bp). But Chairman Jay Powell obviously wanted to push the larger cut through. The focus has shifted from inflation, which has steadily been going down, and is now much more on the jobs market. With employment prospects probably slightly weaker than they were pre-COVID, the Fed has decided to act quickly.
Interestingly, there was initially a mixed reaction by the market. One of the confusing issues with a 50bp rate cut is whether it is done because the Fed is worried about the U.S. economy. But in the speech afterwards, Powell was pretty clear that the U.S. economy is in a good state, that they were just really getting a little bit further ahead because the overall rate is very high relative to what they think is the normalized rate of around 3.25% to 3.5%.
More Cuts?
This rate cut could have been seen as political but I don't think the market will see it that way. In a sense it's one of the uncertainties out of the way. The two big uncertainties going in toward the end of the year were, firstly, what's the Fed going to do? Are they really going to cut rates? And secondly, what's going to happen in the election.
The next meeting is after the election in November. So that’s quite a period of time and the Fed did say that going forward, don't expect 50bp cuts, that wouldn't be the norm. So our view is, we have two more rate cuts through the end of the year. If the data is weaker, we could have a 50bp cut in November and then a 25bp cut in December. We expect there will be rate cuts all the way through to June 2025 where the rate would then be in the range of 3.25% to 3.5%.
The Impact on Emerging Markets and Asset Allocations
There are two types of rate cuts. One is normalized and the other is if things are in trouble. We really have to differentiate between the two. In this case, the U.S. economy is actually in pretty good shape and the Fed is talking about 2% growth this year and 2% growth next year. In my view, it's probably actually stronger than the European economy and the Japanese economy.
Within emerging markets and particularly the rate sensitive markets, this cut could provide an impetus for a number of central banks to cut rates. And I expect we'll see, certainly within the next month, about eight to 10 central banks cutting rates. We believe this really is a turning point for Asia but it's not a big one-off. It will be incremental. We are still a big believer that Asian growth is picking up. It's a much more normalized cycle than it is in the U.S. because the aggregate demand wasn't helped by fiscal policy and handouts. And we think gradual rate cutting will help emerging markets over the next year.
The Sectors
In terms of sectors that could benefit from this and future U.S. rate cuts, ironically I'm going to say some financials. Normally if you were in the U.S. you'd say, well, financials are hurt by rates coming down but financials are hurt by rates coming down because their margins can come down. But if you are of the view that financials in emerging markets are a warrant on the growth of the country and if rates are bringing better GDP, better consumption, then overall it's better for the banks as their books grow.
We're not ready yet to consider deep cyclicals in terms of commodities; that's always traditionally been a play on interest rates, but that's more to do with the weakness in China growth. And normally, in this kind of cycle, we would be buying what I would call cyclicals in tech in Taiwan and Korea. But because of the artificial intelligence (AI) theme they have already run quite hard. So we're a bit more selective there. So really the theme is domestic economies as opposed to more U.S. driven technology.
Beyond Rates
We're still concerned about U.S. growth. In one way, when you look at the rate cycle, you can ask was U.S. growth hurt by rates going up? We don’t believe so, as U.S. growth has been quite strong. And if you ask whether it really benefits from rates coming down, then a lot of that has to do with the duration of mortgages in the U.S. We've had a lot of stimulus, a lot of fiscal spend. And so I think that the upcoming election and the next administration's fiscal policy will be very important. Whether that's to do with tax cuts, tax hikes, how much money is spent, where that money is spent. Additionally, there are the barriers to trade. That's obviously a worry as well, along with geopolitical tensions that can escalate trade issues.
Sean Taylor
Chief Investment Officer
Important Information
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.
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