Finally, Rate Cuts Are Here. Now What?
Author: Kevin McCreadie
October 21, 2024
Kevin McCreadie, AGF’s CEO and Chief Investment Officer, says the question isn’t whether the U.S. Federal Reserve will cut interest rates again, but how aggressive the U.S. central bank will be in lowering them further.
What is your impression of the investor reaction to the U.S. Federal Reserve (Fed)’s first rate cut in more than four years?
Global financial markets reacted much like you would expect at the beginning of a new rate-cutting cycle. Equity market indexes – led by the S&P 500 Index in the United States – climbed immediately higher on the Fed’s announcement in mid-September to cut rates by 50 basis points and they have continued to move higher over the past month, often hitting new all-time highs in the process. While part of this latest leg in the rally can also be attributed to the latest U.S. earnings season getting off to another hot start, what’s been most noteworthy about recent gains to me is the sea change in market breadth that we’ve witnessed over the past quarter or so.
Remember, at this time last year, almost all the S&P 500’s year-to-date positive returns were generated by just seven stocks as investors shunned companies whose bottom lines were more susceptible to higher interest rates. But in the third quarter of this year, that seemed to change with 79% of S&P 500 constituents netting positive gains and 55% outperforming the S&P 500 itself, which returned 4.6% in the three months ending September 30. This is a very good development for equity investors and one that could be instrumental in possibly pushing global equity markets higher in the weeks ahead should it continue.
What do you expect from the U.S. Federal Reserve and other central banks going forward?
It’s fair to expect more cuts as the Fed moves toward a more “neutral” level of interest rates, which, being a theoretical concept, could be anywhere between 3.75% on the high end to 2.25% on the low end, depending on who you ask. So, the question isn’t whether they will cut again. The current Fed rate of 4.75-5% is clearly too high. Instead, the question is how measured the Fed will be in trying to achieve its eventual Goldilocks target.
And herein lies the potential risk. For instance, it’s plausible that an aggressive Fed that cuts rates significantly in a short period of time could result in monetary policy being too loose –especially if the U.S. economy continues to prove more resilient than some anticipate – thus reigniting the embers of inflation. Yet, if the Fed moves too slowly or doesn’t cut deep enough, it’s very possible that the economy weakens from here and, worst case, could tumble into a recession.
Given that dynamic, I believe it will take more than a few months for the Fed to lower rates below 4% and I don’t expect them to fall much more than that – at least not anytime soon. After all, monetary policy usually works with a lag, so caution may be advised. Granted, that may not sit well with some investors who believe the Fed can be much more aggressive without fear of overheating the economy again.
This difference in views could result in greater market volatility going forward, yet the only reason to cut rates zealously is if the economy shows real signs of faltering, which, following last month’s better-than-expected employment figures and last week’s U.S. retail sales data, doesn’t appear to be the case right now. Moreover, if the economy does start to wane significantly, we believe that may not be good for U.S. equity markets – at least initially – even if it prompts a more aggressive response from the Fed. That’s because a dramatic slowdown in economic growth could bode poorly for demand – and therefore corporate profits – in the early going. In fact, bond markets may have it better in a scenario of weakening economic growth and aggressive rate cuts because U.S. treasury yields would likely fall from current levels. This seems particularly true of short-term maturities, but also perhaps longer-dated maturities that may be pricing in a more moderate rate-cutting cycle as well.
Short of that, investors may benefit from being cautious about the Fed taking a pause at some point on the way to neutral. While not the base case, this could trip up global equity and bond markets temporarily, but currency markets too. The U.S. dollar could spike most of all, especially if the Fed takes a break from lowering rates and other central banks like Canada do not.
How could the upcoming U.S. presidential election and escalating geopolitical tensions change this dynamic?
Post the election, there are several policy issues that could change the backdrop for investors – including things like higher tariffs if Donald Trump wins or more stringent regulation if Kamala Harris wins – but the biggest concern is a contested result that isn’t resolved in short order because that would likely erode confidence in the world’s largest economy and lead to greater market uncertainty. Moreover, that uncertainty may force the Fed to respond by lowering rates more than it would otherwise.
The escalating conflict in the Middle East, meanwhile, is deeply troubling from a humanitarian perspective and could have economic consequences as well. The most obvious impact of a full-blown war in the region would be a spike in oil prices, but the repercussions could go beyond that depending on how it plays out.
All in then, investors have a lot to mull heading into the final two months of the year.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
Commentary and data sourced from Bloomberg, Reuters and other news sources unless otherwise noted. The commentaries contained herein are provided as a general source of information based on information available as of October 18, 2024. It is not intended to address the needs, circumstances, and objectives of any specific investor. The content of this commentary is not to be used or construed as investment advice, as an offer to buy or sell any securities, and is not intended to suggest taking or refraining from any course of action. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments Inc. accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained herein.
This document may contain forward-looking information that reflects our current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein.
For Canadian investors: Commissions, trailing commissions, management fees and expenses all may be associated with investment fund investments. Please read the prospectus before investing. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFI is registered as a portfolio manager across Canadian securities commissions. AGFA and AGFUS are registered investment advisors with the U.S. Securities Exchange Commission. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The term AGF Investments may refer to one or more of these subsidiaries or to all of them jointly. This term is used for convenience and does not precisely describe any of the separate companies, each of which manages its own affairs.
AGF Investments entities only provide investment advisory services or offers investment funds in the jurisdiction where such firm, individuals and/or product is registered or authorized to provide such services.
Investment advisory services for U.S. persons are provided by AGFA and AGFUS. In connection with providing services to certain U.S. clients, AGF Investments LLC uses the resources of AGF Investments Inc. acting in its capacity as AGF Investments LLC’s “participating affiliate”, in accordance with applicable guidance of the staff of the SEC. AGFA engages one or more affiliates and their personnel in the provision of services under written agreements (including dual employee) among AGFA and its affiliates and under which AGFA supervises the activities of affiliate personnel on behalf of its clients (“Affiliate Resource Arrangements”).
® ™ The “AGF” logo and all associated trademarks are registered trademarks or trademarks of AGF Management Limited and used under licence.
RO: 20241021-3957686
About AGF Management Limited
Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. Our companies deliver excellence in investing in the public and private markets through three business lines: AGF Investments, AGF Capital Partners and AGF Private Wealth.
AGF brings a disciplined approach, focused on incorporating sound, responsible and sustainable corporate practices. The firm’s collective investment expertise, driven by its fundamental, quantitative and private investing capabilities, extends globally to a wide range of clients, from financial advisors and their clients to high-net worth and institutional investors including pension plans, corporate plans, sovereign wealth funds, endowments and foundations.
Headquartered in Toronto, Canada, AGF has investment operations and client servicing teams on the ground in North America and Europe. AGF serves more than 800,000 investors. AGF trades on the Toronto Stock Exchange under the symbol AGF.B.
For further information, please visit AGF.com.
© 2024 AGF Management Limited. All rights reserved.
Written by
Kevin McCreadie, MBA, CFA®
CEO and Chief Investment Officer
AGF Management Ltd.
