LONDON (Reuters) – When the Federal Reserve delivers a much-anticipated interest rate cut on Wednesday, its first in four years, the move will have ramifications beyond the United States.
The size of the first step and the level of overall easing are open to debate, while the looming US election is another complicating factor for global investors and rate setters, who are looking for guidance from the Fed and pinning hopes on an economic soft landing.
“We don't know yet what kind of cycle this will be – whether it will be like 1995, when there was only a 75 basis point cut, or like 2007-2008, when there was a 500 basis point cut,” said Kenneth Brox, head of corporate research, FX and rates at Societe Generale.
Let's take a look at what's trending in the global markets:
follow the leader
In the spring, when US inflation proved more persistent than expected, investors questioned how much other banks, such as the European Central Bank or the Bank of Canada, might cut rates if the Fed kept its policy on hold this year before their currencies weakened too much, adding to price pressures.
US cuts have finally started to provide relief to regions whose economies are weaker than America's.
As expectations of a rate cut by the Fed have recently risen, traders have been betting on other central banks cutting rates as well.
Still, they forecast fewer cuts in Europe than the Fed, and the ECB and Bank of England are more cautious about remaining inflation risks.
Confidence that the Fed will start cutting interest rates is a boon for bond markets globally, which often move in step with Treasuries.
Yields on US, German and UK government bonds are set to fall in the first quarter since late 2023, when a Fed change was expected.
Rest
Lower interest rates in the US could provide emerging market central banks with more room to ease their actions and support domestic growth.
Nearly half of a sample of 18 emerging markets tracked by Reuters have started cutting rates this cycle, ahead of the Fed, while easing efforts remain concentrated in Latin America and emerging Europe.
But the prospects are dimming due to instability and uncertainty surrounding the US presidential election.
“The U.S. election will have a big impact on this because depending on the different fiscal policies, it really complicates the reduction cycle,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas. “We could see more idiosyncratic actions among central banks on the back of this.”
Relief from strong dollar?
Economies that were hoping that a US interest rate cut would weaken the strong dollar further and boost their currencies may be disappointed.
The dollar has strengthened after the Fed's first rate cut in three of the past four cycles, JPMorgan said.
The dollar outlook will largely be determined by where US rates stand relative to other countries.
Reuters polls suggest the discounts to U.S. rates for safe-haven currencies the yen and Swiss franc could nearly halve by the end of 2025, while sterling and the Australian dollar could post only modest gains against the dollar.
Unless the dollar becomes genuinely low-yielding, it will continue to be attractive to non-US investors.
Meanwhile, Asian economies have gained in markets following the US rate cut, with South Korea's won, Thai baht and Malaysian ringgit surging in July and August. China's yuan has erased year-to-date losses against the dollar.
rally on
The rally in global equities, which was recently halted on growth concerns, could resume if a cut in US interest rates helps boost economic activity and avert a recession.
World stock markets fell more than 6% in three days in early August following weak US employment data.
“There is always volatility at the time of the first rate cut, as the market wonders why central banks are cutting,” said Emmanuel Cau, head of European equity strategy at Barclays.
“If interest rates are cut without a recession, which is the mid-cycle script, the market usually goes up,” Cau said, adding that the bank favors sectors that benefit from lower rates, such as real estate and utilities.
A soft US landing will have a chilling effect on Asia too, although the Nikkei has fallen more than 10% from July's record high due to a rally in the yen and Japan's interest rate hikes.
time to shine
In commodities, precious and base metals like copper will benefit from the Fed's interest rate cut, and the demand outlook and dovish stance are key to subsequent rate cuts.
Low interest rates and a weak dollar are reducing not only the opportunity cost of holding the metals but also the opportunity cost of buying them for those using other currencies, which could fuel the momentum.
“High rates have been a key headwind for base metals, leading to significant downside distortion on physical demand by depleting stocks and pressuring capital intensive final demand segments,” said Ehsan Khoman of MUFG.
Precious metals could also rally. Gold, which typically has a negative correlation with yields because most demand is for investment purposes, typically outperforms other metals during rate cuts. It is at a record high, but investors should remain cautious, said John Reed of the World Gold Council.
“Speculators in the Comex gold futures market are in a similar situation,” said market strategist Reed. “It may be a case of buying the rumor and selling the fact.”
(Reporting by Karin Strohecker, Samuel Indyk, Amanda Cooper and Eric Onstad in London, Yoruk Bahceli in Amsterdam and Tom Westbrook in Singapore; Graphics by Sumanta Sen; Editing by Dhara Ranasinghe and Alex Richardson)