Why Fed Rate Cuts Matter to Global Markets

LONDON (Reuters) – When the Federal Reserve cut widely expected interest rates on Wednesday, its first in four years, the move will resonate beyond the United States.

The size of the first move and the scale of overall easing remain open to debate, while an open U.S. election is another complicating factor for global investors and ratesetters looking for a steer from the Fed and hoping for a soft economic landing.

“We still don't know what kind of cycle this is going to be – will it be like 1995 when there were only 75 bps cuts or 2007-2008, when there were 500 bps,” said Kenneth Brooks, head of corporate research, FX and Rates at Societe Generale. .

Here's a look at what's in focus for the global market:

1/ Follow the leader

In the spring, as US inflation proved firmer than expected, investors questioned how far others like the European Central Bank or the Bank of Canada could cut rates if the Fed held their currencies before they weakened too much this year, adding to price pressures.

Comfort zones facing a weaker economy than the US are finally getting cut

Traders added to bets on rate cuts by other central banks as Fed rate-cut expectations rose recently.

Yet they cut rates less in Europe than the Fed, with the ECB and Bank of England more cautious about residual inflation risks.

Confidence in the start of Fed cuts is a boon for global bond markets that often move in lock step with Treasuries.

US, German and British government bond yields are all set for their first quarterly declines since late 2023, when a Fed pivot was expected.

2/ Breathing space

Lower US rates could give emerging market central banks more room for maneuver to ease themselves and support domestic growth.

About half of a sample of 18 emerging markets tracked by Reuters have already started cutting rates this cycle, leading the Fed, with easing efforts concentrated in Latin America and emerging Europe.

But volatility and uncertainty surrounding the US presidential election cloud the outlook.

“The US election will have a big impact on that because, depending on the different monetary policies, it really complicates the cut cycle,” said Trang Nguyen, global head of EM credit strategy at BNP Paribas. “We see more divergent actions among central banks behind this.”

3/ Strong dollar reprieve?

Economies hoping that a U.S. rate cut would further weaken the strong dollar, lifting their currencies, may be disappointed.

JPMorgan notes that the dollar has strengthened after the first Fed deficit in three of the last four cycles.

The outlook for the dollar will largely be driven by where US rates are relative to others.

The safe-haven yen and Swiss franc could almost halve their respective discounts to US rates by the end of 2025, a Reuters poll suggests, while sterling and the Australian dollar could only gain a marginal yield advantage over the greenback.

Until the dollar becomes a real under-performer, it will continue to retain its appeal among non-US investors.

Asian economies, meanwhile, led the market's advance on the US deficit, with South Korea's won, the Thai baht and the Malaysian ringgit rising through July and August. China's yuan erased year-to-date losses versus the greenback.

4/ Rally On

A global equity rally, which was recently stalled by growth fears, could resume if lower U.S. rates boost economic activity and avoid a recession.

World stocks fell more than 6% in three days in early August due to weak US jobs data.

“You always have a shaky market around the first cut as the market wonders why central banks are cutting,” said Emmanuel Kau, head of European equity strategy at Barclays.

“If you have cuts without a recession, which is the mid-cycle script, generally markets tend to go up again,” said Cow, adding that the bank favors sectors that benefit from lower rates, such as real estate and utilities.

A US soft landing should also play well in Asia, although the Nikkei is down more than 10% from July's record high as the yen rises and Japanese rates rise.

5/ Time to shine

In commodities, precious and base metals such as copper should benefit from a rate cut, and the demand outlook for the latter and a soft landing are key.

Lower rates and a weaker dollar not only reduce the opportunity cost of holding the metal but also speed up purchases for those using other currencies.

“Higher rates have been a significant headwind for base metals, leading to significant negative physical demand distortions from destocking and weighing on the capital-intensive end-demand segment,” said MUFG's Ehsan Khoman.

Precious metals can also gain. Gold, which typically has a negative correlation with yields because most of the demand is for investment purposes, typically outperforms other metals during rate cuts. John Reid of the World Gold Council said it was at a record high, but investors should be cautious.

“Speculators in the Comex gold futures market are positioning for this,” said market strategist Reid. “It could be a case of buying rumors and selling the truth.”

(Reporting by Karin Strohecker, Samuel Indyk, Amanda Cooper and Eric Onstad in London, Yoruk Bahceli in Amsterdam and Tom Westbrook in Singapore; Graphics by Sumant Sen, Editing by Dhara Ranasinghe and Alex Richardson)