While the US Federal Reserve’s decision to cut rates by 50 basis points (bps) came as a surprise that “could be positive for markets in the near term”, BlackRock’s investment experts think it raises the prospects of further volatility ahead.
This will be especially pronounced if growth and inflation “don’t pan out in line” with the soft landing in the Fed’s updated projections, says Jean Boivin, head of the BlackRock Investment Institute.
The Federal Open Market Committee (FOMC) voted 11-to-1 to lower the federal funds rate to a range of 4.75% to 5%, after holding it for more than a year at its highest level in two decades.
In a Sept 19 note, Boivin says the near-unanimity on the decision is “perhaps more surprising than the one dissent”, “given what is an extremely uncertain outlook and the divided opinions before the Fed’s blackout period”.
Governor Michelle Bowman dissented in favour of a smaller, quarter-point cut, the first dissent by a governor since 2005, and the first dissent from any member of the FOMC since 2022.
So, why 50bps and not 25bps? According to Boivin, the simple explanation might come down to Fed Chair Jerome Powell’s comment that the economy is “growing at a solid pace… [and] we want to keep it there”.
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But that suggests that rather than risks being balanced, the Fed is more concerned about growth slowing too much, says Boivin. “There was no explicit acknowledgement of the risk of inflation resurging. Notably, there was no mention of growth being boosted by easy financial conditions that have gotten easier this year — a highly unusual situation when policy is supposed to be restrictive.”
Thus, this “underscores” Boivin’s view that this is “far from a normal business cycle”.
‘Not a full-blown easing cycle’
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Powell did use the word “recalibration” to characterise the policy decision, notes Boivin. “That could be the word he points back to if the Fed pauses rate cuts, and it becomes clear this will not be a full-blown easing cycle. We still think market rate cut expectations will ultimately be disappointed and the positive news will instead come from resilient growth.”
Nevertheless, the key takeaway for many market players is that the Fed will “persistently” lower rates for the next two years, says Rick Rieder, chief investment officer of global fixed income and head of BlackRock’s global allocation investment team. This optimism will resonate through the financial system for the coming months, he adds.
“As interest rates move lower, fixed income assets will benefit from the move, but not necessarily in a straight line,” says Rieder in a Sept 19 note.
“Today’s singular rate cut doesn’t provide the answer to questions surrounding the economy, the upcoming election or how geopolitics will play out from here,” notes Rieder. “Yet, we continue to believe in middle of the yield curve assets, particularly those yielding more than US Treasuries, as they provide great income, as real rates are still high, even though the Fed will be attempting to bring those elevated real rates down in the year to come.”
