Fed Rate Cut Storm: Market Cheers vs Economic Concerns

Tonight, the Federal Reserve is expected to do something it hasn't done since March 2020: cut interest rates!

Despite being prepared, global investors are still nervous, uncertain about how the financial markets and the global economy will react after the rate cut.

The Fed is lagging behind other central banks such as the Bank of England, the European Central Bank, as well as the central banks of Canada, Mexico, Switzerland, and Sweden. They have already lowered interest rates to address economic slowdowns and inflation. But none can impact the markets like the Fed, the world's largest central bank.

Therefore, a rate cut is bound to shake every corner of the financial world.

Currencies, Commodities, and Markets at the Forefront

Changes in interest rates always affect currencies. Always have. Higher rates mean foreign investors can get better returns, thus boosting the value of the relevant currency.

Over the past few years, we have seen the US dollar soar, while Japan and Turkey have seen their currencies collapse due to low rates. The yen and lira have been hit hard, but the dollar has strengthened against a basket of global currencies, hitting new highs throughout 2022. The gap between the Fed's rates and those of other central banks has caused friction.

You see, a stronger dollar makes imports more expensive for countries with weaker currencies, pushing up their inflation rates. Central banks like the Bank of Japan are in a difficult position, trying to keep their currencies weak while controlling inflation.

Although on August 5th, we saw the Bank of Japan potentially as powerful as the Fed, as it single-handedly crashed every financial market (including cryptocurrencies). Bitcoin plummeted below $50,000 in seconds, the first time in months.

Then there's the US economy itself. Weak labor markets and recession concerns are lurking in the shadows. Traditionally, higher rates make gold less attractive as bonds and other fixed-income investments offer better returns. But gold is also a hedge against inflation, and as rates fall, inflation may rise, increasing demand for gold.

Oil and other commodities usually priced in dollars may also benefit from the Fed's rate cut. Lower borrowing costs can stimulate economic activity, driving demand for these raw materials.

Developing and underdeveloped economies are particularly sensitive to US monetary policy. Any move by the Fed could hit them harder than larger economies.

Stock markets? They're not immune either. Wall Street has been on edge since last Friday, swinging with every piece of news about when and how much the rate cut will be.

Dalio's Warnings and Major Global Forces

Before the rate decision, Ray Dalio, co-founder of Bridgewater Associates, listed three interrelated forces driving the global economy.

First: debt, currency, and economic cycles. It's well known that the US holds massive debt. With interest rates at a 23-year high, federal spending on debt repayment alone has reached $1.049 trillion. This is a 30% increase from last year, with the total expected to reach $1.158 trillion by 2024. Ray Dalio wonders how this debt will be managed after the rate cut.

He also raised concerns about internal order and chaos in the US. The upcoming elections have exposed deep divisions, with Kamala Harris now seen as a stronger candidate than Donald Trump, according to a CNBC Fed survey However, apart from who will take office, Ray Dalio pointed out that the power transition itself could be very chaotic, with a huge gap in wealth and values ​​tearing the country apart. Internal political turmoil could in turn lead to more market instability.

The third force mentioned by Ray Dalio is the tension between major global powers. He warned that geopolitical conflicts between these superpowers could easily escalate. Frictions already exist in trade, tariffs, Ukraine, and Iran issues.

Meanwhile, the stock market may be preparing for disappointment. Last week, traders were preparing for a quarter-point rate cut. But now, the market is betting on a half-point rate cut. This change has already driven the S&P 500 and Dow Jones indices to record highs.

CME FedWatch tool shows that traders now give a 63% chance of a 50 basis point rate cut, bringing the current 5.25%-5.50% rate down to the 4.75%-5% range. The probability of a more moderate 25 basis point rate cut is 37%.

JPMorgan Chase warned that if the Fed cuts rates by 50 basis points, it may calm the market by confirming market expectations of aggressive rate cuts until December. But some analysts worry that this may indicate deeper economic problems in the United States.

Historically, a 50 basis point rate cut has often led to poor stock market returns, as was the case during the Great Financial Crisis and the bursting of the dot-com bubble. There are strong reasons to support a faster pace of rate cuts. But there is a lot of uncertainty.

Moreover, Jerome Powell and his team keeping the market in the dark so close to the next US presidential election is unusual. Due to differing opinions within the Federal Reserve Committee, no one can be sure which way the decision will go.

All we can do now is wait