Following the US Federal Reserve’s 50 basis points (bps) rate cut on Sept 18, announced during its Federal Open Market Committee (FOMC) meeting, pundits, economists, strategists and everybody in between have weighed in on the outlook for the global economy, stocks, bonds and everything else.
First off, where are interest rates heading? In a word, the answer is down. In a Sept 19 note, Selena Ling, OCBC’s chief economist and head of global markets research & strategy; and Frances Cheung, head of foreign exchange (FX) and rates strategy, say they expect to see another 50bps of cuts, with 25 bps each at the remaining two meetings this year. They are on Nov 6–7 and Dec 17–18.
The OCBC duo are keeping their estimate of a 125 bps cut in 2025. “These expected rate cuts, if materialised, will bring the target range for the Federal funds rate to 3%–3.25% by end-2025.”
UOB’s senior economist Alvin Liew and the global economics and market research team are also expecting another 50bps of rate cuts in 2024. Liew is expecting to see a 100bps reduction in 2025.
He also projects the terminal rate to be at 3.25% by early 2026 compared to the Fed’s longer-run view of 2.9%.
“As we have pointed out earlier, the Fed has nudged up the longer run median view of the [Fed funds target range or FFTR] in the last two dot plots, so we will not be surprised that it will be lifted further towards 3.0% handle in the subsequent reports, thus likely converging towards our terminal rate projection,” he writes in his Sept 19 note.
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Cash is no longer king
With interest rates falling cash will look “increasingly unattractive” over the next two years, says Vasu Menon, managing director, investment strategy at OCBC.
The rate cuts should “augur well” for investment markets with the “Powell Put” in play, which should support risk appetite.
“A supportive Fed and a resilient US economy provide a supportive backdrop for equities, bonds and gold,” writes Menon.
“Bear in mind that it’s not just the Fed that’s cutting rates; other central banks are following suit. This should help to ease global financial conditions, prove counter-cyclical and support investment markets as well,” he adds.
While investors may have to ride out a period of elevated volatility with the US presidential elections in early November, Menon says there is no reason for concern as the medium-term trajectory for equities is still “northbound”.
“Volatility and corrections are normal in a bull market and do not alter the positive medium-term undercurrents,” he says (see Chart 1).
DMs to benefit more than EMs
Developed markets (DMs), such as Hong Kong, Singapore and Australia, are likely to benefit more than emerging markets (EMs) like China and India.
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“Many DM stocks trade on their dividend yield [a function of earnings] and could rise if rates are falling,” says the team of Morgan Stanley analysts in their Sept 18 report.
“DM stocks are also sensitive to their asset and book values, which can rise if cap rates fall,” they explain. “By contrast, EM stocks are more driven by local demand/supply and regulations. Japan is somewhat unique in the sense that its interest rates are expected to rise.”
In Singapore, the team likes CapitaLand Investment (CLI) as it is a beneficiary of the revival of property transactions. That said, the team is less upbeat on fellow property group City Developments (CDL) as it sees limits to capital return upsides due to fundamental headwinds.
Equities and fixed income
With the abating interest rates that were held unusually high compared to the weaker regional and domestic inflation trends in Asia, now is a good time for global investors to load up on Asian fixed income for their portfolios, says Navin Saigal, head of Asia macro for fundamental fixed income at BlackRock.
He also remains upbeat on middle-of-the-yield curve assets, especially those with higher yields than US Treasuries as they provide “great income” as real rates are still high. However, the Fed will also be attempting to lower those elevated real rates in the year to come.
Kerry Craig, global market strategist at JP Morgan Asset Management, remains “overweight” towards risk assets in equities and credit, given the low risk of a recession.
He also likes the US equity market, which, despite its “high valuations”, represents a “quality bias” that may be “wise” for investors. Within the sector, Craig sees opportunities in utilities and financials.
“Defensive sectors may benefit from falling bond yields while the distinctions between growth and value blur,” he adds.
Globally, Craig notes that earnings in Japan are “picking up”.
In fixed income, Craig sees opportunities in the US Treasury market, especially in the “belly of the curve”. Investors may also consider European bonds and markets with steeper yield curves like Australia.
“Credit remains appealing, with investment-grade and high-yield bonds seen as non-recessionary assets,” he says. “Spreads are narrow, but yields are respectable, and the reinvestment risk is rising as yields fall. The outlook suggests range-bound yields, with potential downward pressure as the rate cycle progresses.”
Bernd Hartmann, VP Bank’s head of CIO office (chief strategist), is looking forward to market rotation.
“These include small and mid-caps and industrial metals, for example,” says Hartmann. “Shares of the dominant technology companies are already increasingly struggling. It is still uncertain whether the rotation into lagging segments will begin. VP Bank recommends keeping an eye on these segments, and that investors focus on the soft landing scenario.”
HSBC Global Research’s team of analysts are keeping its bullish outlook on long-dated US Treasuries with its forecast for the 10Y yield at 3.5% for end-2024 and 3.0% for end-2025.
“It is too early to reduce the bullish stance for bonds. The 50bps rate cut and projections in the dot plot validated the market’s expectations of a dovish Fed going into the meeting,” the team writes in its Sept 18 report.
Ray Sharma-Ong, abrdn’s head of multi-asset investment solutions for Southeast Asia, expects long-duration sectors such as the global markets and Asia infotech and healthcare to benefit from an easing rate environment. Interest rate beneficiaries such as South Korea, Taiwan, India and Asian REITs could see better days, too.
That said, Sharma-Ong warns investors to be “selective” in the type of risk to position for, with the US elections less than two months away and with Democratic nominee Kamala Harris at her widest lead compared to her Republican counterpart Donald Trump in odds.
“Any additional pricing in of her win will be a drag for broad market equities due to corporate tax proposals,” he notes.
The Standard Chartered team is “overweight” on US equities given the potential of a soft landing and a strong earnings outlook. In addition, they would use any bounce in the US government bond yields towards 4% to “lock in an attractive income”.
“Markets are pricing in 200bps of rate cuts by end-2025. A Fed path less aggressive than this would likely lead to such a rebound in bond yields and the USD,” says the team in its Sept 19 market watch report.
Gold and oil
A soft landing may see headwinds for gold, says VP Bank’s Hartmann. “If a recession is avoided, the price of gold will stagnate. The support provided by falling interest rates is offset by diminishing uncertainty. Price gains only occur over a period of 12 months.”
Phillip Nova analyst Priyanka Sachdeva notes that the immediate reaction in the gold markets seemed “off” as investors seemed to believe that there is an inherent weakness in the US economy, thereby leading the Fed to cut rates at a faster pace.
“Some of it looks justified especially as weakening signs from mainland China are already weighing on sentiments,” says Sachdeva in her Sept 19 report. “Insignificant buying from central banks in August also adds to bearish sentiments. But even if the current backdrop points to economic weakness ahead, shouldn’t that swing some fund flow to safe-haven bullion?”
From a technical view, she sees gold continuing to remain bullish in the short- and long-term although the extent and timing of the upswing could depend on the Fed’s rate cut timeline and magnitude.
The larger-than-expected cut and the surprise rally in the US dollar weighed on the dollar-denominated crude oil.
The cost of money
Companies with high gearing ratios could benefit as interest expense is likely to fall during refinancing. Thiveyen Kathirrasan, The Edge Singapore’s in-house analyst, often says interest rates are the cost of money. From a macroeconomic perspective, generally, when interest rates rise, stocks and equities tend to underperform. This is because a rate hike is meant to control inflation and hence does the opposite of stimulating economic growth, which negatively affects the growth of stocks.
The new interest rate tide should lift all boats, including troubled ones. More directly, prevailing interest rates impact the weighted average cost of capital (WACC). “The WACC is the discount rate, or the required rate of return when valuing a business. It is divided into two parts, which are the cost of equity and the cost of debt. Simply put, the cost of equity is affected by the risk-free rate, which in most cases is the 10-year government Treasury bond,” Kathirrasan says.
Higher interest rates directly impact the risk-free rate, and hence, the cost of equity would be higher when interest rates rise, he explains. The cost of debt is also affected as higher interest rates increase the cost of borrowing. “Overall, higher interest rates increase the WACC, and conversely, lower interest rates reduce the WACC which in turn reduces the required rate of return of the stock,” Kathirrasan concludes.
Table 1 comprises the stocks with the highest gearing ratios, and their Altman Z-Scores and Bloomberg Default Risk Probability. Although the Z-scores are low for some of the stocks, the Bloomberg scores show low rates of default. In sum, the Fed has thrown these stocks a lifeline.
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