Global Central Banks Are Already 'On The Move', But Will They Affect Fed's Decision In September?

This year, Switzerland, Sweden, Canada, the Eurozone, and the UK have all taken action earlier than the Federal Reserve, which is historically seen as a leader in monetary policy. Central banks of these economies need a strong justification to act before the Fed does, as these moves carry risks of instability and currency devaluation.

As the manager of the world's largest economy, the Fed usually sets the tone for monetary policy, and its actions or inaction always have a global impact.

Interest rate changes in other countries may not have a significant impact on the Fed, but observing the behavior of other central banks may provide clues for expectations of the US economy and stock market when interest rates begin to decline.

By acting later than its peers, the Fed may now need to act more quickly to prevent the US economy from slowing down too much— the market expects four 25 basis point rate cuts by the end of the year, more than other countries. However, a fact demonstrated by other central banks is that even taking a step earlier in rate cuts may not be enough to prevent an economic slowdown. The boost to the stock market may also fade quickly.

Nomura Securities economist Andrzej Szczepaniak said, Because the Fed decided to wait, it may have to go a bit more sharply, but the macro outlook in the U.S. is still pretty resilient. Now it's all about the labor market.

Europe was more concerned about its economy earlier than the Fed, with several countries in the Eurozone and the UK experiencing some contractions at the end of last year.

Like the Fed, other central banks are trying to find a balance between slowing down price increases and preventing a surge in unemployment.

In March, the Swiss National Bank cut its benchmark interest rate by a quarter of a percentage point to 1.5%, and it was reduced again to 1.25% in June. Inflation was already well below 2%, and this early action helped the Swiss franc depreciate against the US dollar and the euro. Meanwhile, economic growth in the second quarter accelerated from the first quarter. The Swiss National Bank, which predicts moderate growth this year, will make its next decision on September 26.

In May, it was Sweden's turn, marking the country's first rate cut since 2016. This also helped the Swedish krona depreciate, making Swedish exports more competitive. However, growth in the second quarter still slowed down compared to the first quarter. The Riksbank cut rates again in August and said it might cut rates three more times this year to get the economy back on track.

The Bank of Canada began cutting rates in June and continued to do so in July and the latest decision was on September 4. Inflation is still above target but is slowing down. Concerns about slowing economic growth for the rest of the year are also intensifying.

Then there's the European Central Bank, the second-largest central bank responsible for the 20 countries in the Eurozone, which made a 25 basis point rate cut in June, which had been signaled for months. When the central bank took action, inflation was actually rising - it also raised forecasts for economic growth and inflation at the time.

But since then, the outlook has worsened. Szczepaniak of Nomura Securities predicts that the ECB will cut rates again this month and once more before the end of the year. He said the Fed might also take action three times this year.

He added, The market may be getting ahead of itself in thinking that the Fed will be doing even more than the ECB.

Among the major Western central banks, the Bank of England stands out. The UK's inflation rate returned to the 2% target as early as May, and it did not make its first 25 basis point rate cut until August, with a close vote among the nine rate decision-makers. Since then, data has shown that inflation rose again in July. The Bank of England also raised its growth forecast for this year, indicating it may be less willing to cut rates further.

Two lessons can be learned from all these examples: The first is that if the economy has already begun to cool down, a few rate cuts cannot stop this situation—as the high interest rates at the beginning of 2022 had a lag effect in curbing a surge in inflation. However, this point is often overlooked.

When Powell says that the Fed is equally concerned about the labor market and inflation, he is talking about a point in the future. The US unemployment rate rose to 4.3% in July, the highest since October 2021.

The second lesson is that the stock market's reaction to the expectation of rate cuts is greater than the actual rate cuts. Since March, the Swiss SMI index has fluctuated and remains below its 2021 highs. The FTSE 100 has not set a new high since May. Meanwhile, the STOXX Europe 600 and the Canadian stock market index hit historical highs at the end of August. In contrast, although the S&P 500 is currently close to its historical high, it has not set a new record since July.

In summary, when central banks start cutting rates, whether inflation has returned to target levels seems irrelevant - the key is that interest rate expectations will return to target levels. In contrast, the help of rate cuts to the economy will mostly only become apparent long after the rate cuts happen.

 

The impact on the stock market seem more related to when the expectation of lower interest rates is consolidated, rather than when they occur - so the Fed's boost to the stock market may already be over.