Investment Strategies
Fed Buys Economic "Insurance" With Rate Cut - Wealth Managers React

The world's most powerful central bank has cut rates. Wealth managers give their reactions.
The US
Federal Reserve has cut interest rates by 0.25 per cent, or
25 basis points, to a target range of 2 per cent from 2.25 per
cent. This is in spite of what is, as far as data seems to
suggest, a strong economy without much slack in the system.
Economists argue, however, that fears about an escalating trade
war may require an “insurance”-style cut now and the markets
appear to be pricing in further reductions.
The decision was not unanimous: Kansas City Fed chief Esther
George and Boston Fed president Eric Rosengren dissented on the
decision to cut rates, instead preferring an unchanged stance on
interest rates.
Older investors may scratch their heads about how the world’s
most powerful central bank thinks it is necessary to loosen
monetary policy when – according to the Trump administration and
official figures – the US economy is in such good shape. It is
important to remember that when inflation (which is low) is
factored in, real interest rates are barely positive. Over time,
lousy returns on cash and cash-like investments hold down
savings, and that’s bad for the kind of long-term investment that
drives productivity growth and real wages. It has been argued
that one of the reasons why wage growth has been sluggish in
recent years is precisely because of low real savings rates in
the US (and to some degree, other parts of the West). There is
also the argument that the Fed has so massively expanded its
balance sheet post-2008 that it has limited room to keep rates
higher even if the economics warranted it.
Low interest rates also mean, as wealth managers know, that
investors must go higher up the risk spectrum than they might
otherwise like to get returns. It also explains some of the
hunger for alternative investments, such as private capital,
equity, forms of real estate, infrastructure, commodities, and
precious metals. The environment has prompted investors to be
willing to take the pain of less liquidity because they need the
returns. Sooner or later, this equation is not going to add up
any more.
With these thoughts out of the way, here are some reactions from
wealth managers in Europe from yesterday’s cut by the Federal
Reserve. We may update with reactions from US managers as they
come in. To add your voice to the debate, email tom.burroughes@wealthbriefing.com
UBS Global Wealth Management Chief Investment Office,
UBS
Over the coming months, the progress of trade talks between the
US and China will influence the outlook for the economy and the
Fed. While we do not expect a breakthrough leading to a reduction
in tariffs, we believe that talks are likely to continue with no
major escalation in tensions. This should, in our base case,
permit a gradual recovery in business confidence, and a reduction
in market expectations for Fed rate cuts.
Over the medium term, we will be watching how the Fed evolves its thinking around its statutory goals of "maximum employment, stable prices, and moderate long-term interest rates". Inflation has consistently fallen short of the Fed's 2% target despite interest rates being lower than in the past, and market pricing indicates scepticism that the Fed will hit the target in the future. The Fed may embrace a new interpretation of maximum employment, or somehow suggest that inflation will be encouraged to rise above 2 per cent to make up for the shortfall in previous years. It may also introduce new monetary policy tools to help reach its goals and to provide more support during economic downturns.
Investec
Economics
Looking forward, we expect the Fed to sanction two further cuts
in the Federal funds target rate range, effectively to provide
‘insurance’ against downside risks and in response to muted
inflation pressures. We see the next 25bps cut occurring in
September, followed by a further reduction in Q1 2020, which
should see the Federal funds rate bottom out at 1.50-1.75 per
cent. Although [Federal Reserve] chair Jerome J Powell didn’t
deliver any firm commitments on interest rate cuts, he will get
another opportunity at the Kansas City Fed Economic Symposium,
better known as Jackson Hole, on 22-24 August, where he could
provide updated guidance to markets.
The Fed’s decision was framed against an assessment of the
economic outlook which was pretty much unchanged from the June
meeting, in that the labour market was still assessed to be
strong and that activity was seen rising at a moderate pace.
Meanwhile inflation continued to be assessed as running below the
Fed’s 2 per cent target. In light of the solid labour market and
seemingly robust economy the rationale for last night’s cut came
in the form of concerns around downside risks from the global
backdrop (trade frictions) and muted inflation pressures. Indeed
we very much view last night’s move as a precautionary cut given
that the unemployment rate stands around a 50-year low and given
our expectation that the US should see growth of 2.5 per cent
this year.
Mr Eli Lee, head of investment strategy, Bank of
Singapore
Following this 25bps cut in July, another 25bps cut will likely
follow sometime in Q4 2019, although a third cut will depend on
further developments in trade and the economy.
We also expect rate cuts from other central banks in the next few months following the Fed, and note that some emerging market central banks, such as the Bank of Korea, Bank Indonesia and the South African Reserve bank, have already moved ahead of the G3.
With our baseline scenario of synchronised global easing and a
limited likelihood of a recession over 12 months, we believe the
overall environment continues to be supportive of risk assets and
recommend that investors remain engaged with markets.
Olivier Marciot, investment manager, Unigestion
After a period of patience and economic assessment earlier in the
year, the Fed is now taking action. Tonight’s [Wednesday’s]
decision is probably the first step in a sequence of adjustments
in monetary policy, aimed at reviving economic expansion and
bringing inflation closer to the bank’s 2 per cent target.
With this in mind, our current dynamic assessment articulates
around three risk factors:
Macro risk: Growth conditions as indicated by our proprietary
'nowcasters', have stabilised around potential and show only
minimal signs of improvement. The latest GDP print in the US is
reassuring but remains the exception in the developed world. On
the other hand, disinflation is still at work and remains the
main source of concern for central bankers. This in turn will
warrant larger accommodation for longer from central banks, until
fundamentals materially firm. In the medium run, this dimension
will remain supportive and benefit growth-oriented assets such as
equities and credit.
Market Sentiment: Risk appetite remained solid through July, and
should remain so now that the Fed has provided clarity on its
future course of action. It would require a shock to reverse
current optimism, such as a rapid surge in trade war tensions or
a poor earnings season, for example. In the absence of a trigger,
momentum should persist as positioning does not seem extreme yet
and leaves room for another leg of positive returns. The picture
is less clear on this front though, as expectations and market
pricing were high going into today’s FOMC meeting.
Valuation: Most assets have become rich as a result of central
bank action. Currently, hedging assets are more expensive than
risky assets, which could trigger correlation distortions and
limit their defensiveness. This favours relative value plays over
long beta exposures.
Tim Drayson, head of economics at
Legal and General Investment Management
The Fed cut rates last night by 25bps, but the lack of forward
guidance disappointed an aggressively priced market which has
taken out 10bps of future cuts.
In the Fed’s Open Market Committee statement the description of
the domestic economy remained the same, and forward guidance was
slightly watered down as the committee stated its intent to
continue monitoring incoming information rather than ‘closely’
monitor. There were two dissents in favour of no change: George
and Rosengren. While both are regional Fed presidents, two
dissents is unusual and suggests a split on the FOMC. However,
nobody dissented in favour of a 50bps cut. The statement outlined
that the Fed will conclude the reduction in its balance sheet two
months earlier than previously indicated. It did not come as a
surprise, as to continue shrinking the balance sheet would work
at cross purposes to the rate cut (even though the balance sheet
was originally supposed to be separate from active monetary
policy decisions).
Gregory Perdon, co-CIO at Arbuthnot Latham,
the UK private bank
If Powell wants a good book deal, he should stand-up to the
President and tell him that the last time he (Powell) checked,
the Fed was in charge of monetary policy not the White House. The
S&P is at an all-time high, unemployment is rock solid,
little cracks in the housing façade and credit is largely okay
(except some low grade). Why did they do it? It doesn’t seem
sensible to me.
Whatever happened to the theory that we need fuel in the tank to
support us during a real downturn? There is no evidence of a
material slow down, so why is the Fed cutting? Let’s face it, the
trade wars will end before the next Presidential election
regardless of what deal Trump can secure - and when that happens,
international trade will come roaring back and confidence will
rocket – at that stage, the Fed will be forced to backtrack and
shock the market. Do markets like reverses? Of course not.