Central banks worldwide are gearing up to begin or continue cutting interest rates this fall, signaling the end of a period of historically high borrowing costs.
In September, the U.S. Federal Reserve is almost certain to join the European Central Bank, Bank of England, People’s Bank of China, Swiss National Bank, Sweden’s Riksbank, Bank of Canada, Bank of Mexico, and others in lowering key rates, which have remained at levels unseen since before the 2007-2008 Financial Crisis.
Money markets had already fully anticipated a rate cut from the Fed, and last week investors became even more confident in the upcoming easing measures.
Global Rate Cuts on the Horizon
At the annual Jackson Hole symposium in August 2024, Fed Chair Jerome Powell indicated that "the time has come for policy to adjust" and emphasized that the central bank would focus on both maintaining a strong labor market and advancing progress on inflation.
Current market expectations, according to CME’s FedWatch tool, suggest that the Fed may implement three 25-basis-point cuts before the end of the year, aligning it with its global counterparts despite a delayed start.
For the global economy, this suggests a generally lower-rate environment in the coming year and a significant reduction in inflationary pressures. In the U.S., recent recession fears have eased, and while major manufacturing economies like Germany show some weakness, service-oriented economies such as the U.K. are experiencing solid growth.
Market Impact on Rate Cuts
The impact on markets is less certain. European stocks, as tracked by the Stoxx 600 index, recovered in 2023 from the previous year's downturn, gaining nearly 10% year-to-date and reaching an intraday record high on Friday. In the U.S., the S&P 500 index has risen 17% so far in 2024. The VIX volatility index, which surged during the global equities slump in early August, has returned to below-average levels.
As we enter the traditionally weaker months of September and October, market fluctuations are to be expected, driven by factors such as geopolitics, corporate earnings, and developments in sectors like AI. Despite supportive Fed commentary for stocks, recent August’s U.S. jobs market data, the U.S. economy added 142,000 jobs last month, falling short of economists' expectations.
Arnaud Girod, head of economics and cross-asset strategy at Kepler Cheuvreux, told CNBC that while bonds have performed well and equities have rebounded, investors now face uncertainty regarding the future trajectory of the U.S. economy and the pace of rate cuts. “The more rate cuts you see, the higher the chance they come with negative data, which could weaken earnings momentum. So, it’s challenging to remain too optimistic,” he said.
Girod also pointed out that the stock market has shown some indifference to interest rates, as evidenced by the rally in Big Tech stocks during the peak rate periods. He emphasized that key events, such as Nvidia’s earnings, will remain critical to watch.
Impact on the Futures Market
Several factors influence changes in futures prices, including the spot price of the underlying asset, the risk-free interest rate, interest income, storage costs, and the convenience yield. The spot price, risk-free rate, and storage costs tend to have a positive correlation with futures prices, while interest income and the convenience yield have a negative correlation. The link between risk-free rates and futures prices is grounded in the no-arbitrage assumption, which is generally maintained in efficient markets.
With the Federal Reserve expected to cut interest rates soon, futures traders are gearing up for potential changes in contract prices. Typically, falling interest rates benefit futures traders by supporting higher contract prices. Traders who anticipate these rate cuts might profit from long positions in certain futures contracts.
Interest rate futures, in this context, provide valuable tools for hedging against rate movements. For instance, borrowers might use futures to secure lower rates ahead of expected cuts, thereby reducing borrowing costs. Meanwhile, speculators could use these hedges to take advantage of variable rate movements, positioning themselves to benefit from the anticipated easing cycle.
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