The US Federal Reserve has been taken by surprise. Having started its policy rate-cutting cycle strongly (by a 0.5% decline), it faced a job market starting up again and rising bond interest rates. Where is the US economy going?
The landing will have to wait
Evoking the labour market's weakness, the Fed has enthusiastically moved to lower rates, with a 0.5% cut, which sets its key rates in the interval 4.75% -5.0%. Investors have been reassured. For them, a decline in the cost of credit at a time when the economy was still holding up showed an attentive Fed to the needs of the markets, ready to do everything to achieve a soft landing for the economy.
However, the labour market figures published in early October undermine this logic. Job creation remained strong (+254k jobs created), the unemployment rate fell to 4.1%, and hourly wages rose by almost 4% over a year, faster than inflation. This means that more US households can afford to spend. And since the cost of credit is decreasing, there’s a good chance they won’t be without it. Far from preparing to land, the US economy seems determined to stay in flight, keeping activity levels moderate.
In addition, oil prices have started to rise again, given the latest developments in the Middle East and the attempts at recovery in China. These factors increase the chances of a rebound in inflation at a time when the Fed was not necessarily expecting it.
This raises several questions about the future of US monetary policy. In the weeks leading up to the unemployment figures, investors had begun believing there would be a second 0.5% cut in key interest rates on 7 November. Today, the 0.25% drop attracts investors' favour. But gradually, the idea that the Fed may have gone too fast in its work and will have to settle for a further rate cut at its next meeting is gaining ground.
The bondholder turns around
Naturally, such scenarios impact markets. Fixed income rates have been on the downside for more months, having bet that inflation was defeated and that there would be many rate cuts, and have changed their minds. From around 3.6% a month ago, the US 10-year rate has risen slightly above 4.0%. It is the same path for the two-year rate, ending at just over 4%. The yield curve is, therefore, flattening at a high level, indicating that investors think the margin for the Fed to lower its rates many times will be smaller. If their appetite for bonds is less, it is also because they prefer equity exposure in an economy that will continue to grow. At the same time, the new policies announced by China have attracted foreign capital to this country, which had long avoided it—fewer buyers of US debt.
The US debt market is a benchmark for the rest of the world, so the rebound in US interest rates has a global impact. Even though inflation in the euro area is now within the targets of the European Central Bank, and a further decline in European key rates is expected, long-term rates in the euro area have also been rising slightly. This is particularly noticeable in France, where the 10-year rate now exceeds 3.0% (compared to 2.8% a month ago) due to uncertainty about the country’s ability to consolidate its public finances. This is a severe warning to the ECB: it may lower its key rates if the United States offers much higher bond market yields - increasingly competitive since debt continues to increase - Investors will direct their savings towards the green bill.
The rebound in US rates is also bad news for the emerging world, which was betting on cheaper financing terms shortly. He will have to be patient again.
The dollar is coming back to life
The US dollar is taking advantage of these latest developments to recover its colours because the more attractive returns and the excellent performance of the stock market attract foreign capital. Traded around 1.12 USD a few weeks ago, the euro is now back to around 1.09 USD. At this level, the dollar is overvalued against the single currency. But should we be surprised? The prospects on the other side of the Atlantic are for continued growth, thanks to a considerable capacity for innovation that allows its giants to dominate the world markets without sharing.
Europe is waiting for the ECB’s rate cuts to be the magic wand that will allow it to recover. However, in the absence of significant reforms, this remains highly unlikely. If European stock markets are doing well, it is partly because investors see it as a cheap way to gain exposure to the US or Chinese consumers. Elsewhere, Japan is trying to stay afloat while China is doing what it can to correct the mistakes of the past. However, at this point, none of the major economies can compete with the US, and no other country could show such dynamism with a high cost of credit.
The name of the next president is irrelevant
Of course, the presidential election carries with it uncertainty for the future. But investors would settle for both candidates. Trump promises 7.5 billion in tax cuts that will affect both companies producing in the US and the elimination of taxes on social benefits, among many others. To offset these tax cuts, Trump is betting on increased tariffs (10% to 20%). Harris takes over from Biden, with USD 3.5 billion in tax cuts, especially for households earning less than USD 400,000/year. A shortfall will have to be made up by the wealthiest businesses.
As we know, Biden has yet to progress on this front, exploding deficits to more than 7% on average since 2021. Harris should stay on the same track. If there are doubts about the US interest rate trajectory, there is little doubt that this market has its dynamics and many assets that will continue growing moderately. We continue to invest in them as part of our diversified portfolios.