As expected, the Federal Reserve has cut interest rates in the US by 0.25%.
This is the first drop in rates since 2008 when the Fed was completing an aggressive move to counter the unfolding financial crisis. It had cut rates from 5.25% to just above zero in a year and they remained at that level until the Fed led the world in normalising monetary policy in 2015.
Since then rates have got no higher than 2.25% to 2.5% and, at least for now, have peaked at a much lower level than in previous tightening cycles.
This ‘dovish’ move is in stark contrast to the beginning of the year when markets were expecting the Fed to raise rates four times over the course of the year.
Jay Powell, the Fed’s Chairman said the cut was a “mid-cycle adjustment to policy” rather than “the beginning of a lengthy cutting cycle”. These comments disappointed investors, as some were expecting a 0.5% cut, with hints of further reductions to come. In response the S&P 500 index had its biggest one-day drop in two months.
The Fed has used precautionary rate cuts in the past to prevent recession. Most notably, it did this in the late 1990s when two sets of rate cuts extended the economic cycle until the dot.com bubble burst in the year 2000. But recent economic data have suggested the economy might be stronger than the Fed fears. Retail sales and job creation numbers have been better than expected. Last week, it emerged that the US economy grew at 2.1% in the second quarter, a bit faster than forecast.
But the Fed now fears growth in the US may be slowing, with many overseas markets where American firms make a lot of their money already in recession.
The actions of the US President can also be seen as a factor in this decision. Mr Trump, keen to win another term next year, wants rate cuts to fuel the economy and has been putting pressure on the Fed for some time. After a boost from his corporate tax cut in 2017, his trade war rhetoric may now be harming manufacturing and hurting sentiment globally at a time when we may already be past the peak of the economic cycle.
Meanwhile, this side of the Atlantic, the picture is more complicated due to the ongoing Brexit uncertainty. In the period since the 2016 referendum, the US has raised rated rates nine times, while the Bank of England has raised rates just twice and one of those was to reverse an emergency rate cut after the referendum.
Today the Bank of England Monetary Policy Committee said rates would remain at 0.75%, while it waits to see which way Brexit goes under Britain’s new government.
The pound has been under pressure as markets start to worry about the prospect of a no-deal Brexit at the end of October. Since May, sterling has depreciated by 7% against both the dollar and the euro. A cut to UK rates would only weaken the pound further making our imports more expensive, which in turn could push up inflation above the government’s 2% target.
So what can we learn from the central banks this week? One thing that’s abundantly clear is that there’s a lot of uncertainty around, whether it’s the outcome of President Trump’s trade war with China or the fate of the UK come the 31 October.
The actions of the banks suggest this era of lower-for-longer interest rates isn’t about to end soon, meaning savers will be forced to look at riskier assets such as shares and bonds to beat the lacklustre returns of cash savings accounts. In times like these, taking a diversified approach to investing, where your money is spread across different assets and geographies means the risk of making the wrong choice is minimised.
The Fidelity Select 50 Balanced Fund takes such an approach by investing across a range of asset classes and regions to find potential future growth wherever it can be found. My colleague Emma-Lou Montgomery recently interviewed the fund’s manager Ayesha Akbar.
More on the Fidelity Select 50 Balanced Fund
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