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Will the Fed cut interest rates by 0.5% right away? More from our Global CIO Private Bank, Michael Strobaek
Article published in NZZ am Sonntag, 15 September 2024.
The US Federal Reserve is facing a significant change of direction: on Wednesday 18 September, it is expected to cut interest rates for the first time, which it had previously raised from 0 to 5.5 percent in 2022 and 2023.
Many experts were sure at the time that this massive increase in the cost of credit would completely stifle economic growth in the USA – and this fear still exists.
No recession
However, Michael Strobaek, Lombard Odier’s chief investment officer, is certain that it will not come to that. “I still don't think we’re going to have a recession, even if the weak labour market data in the U.S. suggests so.” Usually, unemployment figures are very meaningful, but in this cycle everything is different, Strobaek points out.
“We live in a post-Covid world that has been flooded with liquidity.” Regardless of the fact that the labour market is weakening, consumer sentiment is still relatively positive.
The Danish-born economist also sees no signs of stress in the corporate sector. On the contrary, the risk premiums that companies have to pay for their loans are very low. And the momentum in the American economy is still very high. “In short, we assume that there will be no recession despite the weaker labour market figures.”
That would be a small miracle: historically, such a sharp rise in interest rates has almost always led to a phase of negative growth. Strobaek does not deny this.
Weakening labour market
“But you have to see that people have been talking about a recession for two years now. First because short-term interest rates were higher than long interest rates, and more recently, after the yield curve returned to normal, because of the weakening labour market.”
Strobaek expects the Fed to be primarily concerned with avoiding further mistakes, having previously grossly underestimated the rise in inflation, which “has become a huge problem” in 2022 and 2023
The Fed has a dual mandate of price stability and maximum employment. Now that inflation is normalising but the labour market is weakening, the Fed is likely to focus more on the second part of its dual mandate, according to Strobaek. He therefore expects a first interest rate cut of 0.5 percentage points this week.
Read also: US election scenarios and investment implications
An interest rate cut of 0.5 percentage points
“We believe that the Fed will then cut interest rates by a quarter of a percent at every meeting after September this year – and that we will then end up at a level of 3.5 to 4 percent by the end of 2025.”
While interest rate decisions are central to the markets, according to Strobaek, the name of the next US president is secondary. This effect is overestimated every time.
“Whoever comes to the White House wants to ensure that the economy continues to run and that inflation remains under control.” Of course, there would be differences: “Under Trump, there would be tax cuts, deregulation and an increase in trade tariffs. The Democrats are certainly more reserved.”
Strobaek also sees only modest effects on US foreign policy, where Harris and Trump position themselves quite differently. “"The Ukraine war has virtually no impact on the markets.”
Major risk Middle East
The situation in the Middle East is more dangerous, where the Biden administration has so far tried to de-escalate the situation. “Trump would probably show less restraint, and if elected, he could even urge Israel to take tough action against Iran and its allies. Of course, this is dangerous and would have a strong impact on the price of oil and thus on economic growth.”
Read also: From Geneva to Dubai: Lombard Odier shares its private banking ambitions in the Middle East
Strobaek even sees an escalation in the Middle East as one of two main risks for the financial markets. The other is that inflation could prove to be more persistent than expected.
What conclusions should investors draw from his assessment that a soft landing will succeed and that elections will have no influence on the stock markets?
Buy shares, Strobaek thinks. But he is no longer betting on a preponderance of American assets: when he joined Lombard Odier, he urged that American stocks, bonds and also the dollar be given greater consideration than the global indices actually provide.
USA no longer in the foreground
What has worked well so far is now reaching its limits. “We are on the verge of buying even more stocks, but not in the US, but in Europe, Switzerland, Japan and Asia excluding China.” The further upside potential for bonds, on the other hand, seems limited.
Read also: Politics and markets: navigating the edge of reason
Why is he not willing to invest in Chinese stocks – even though their valuations are very low? “China is no longer the country it used to be.” The demographic decline is a heavy burden, and the old recipes, namely building infrastructure and houses on a large scale, hardly bring any added value. “Now China has to reinvent itself at a time of geopolitical tensions.”
The risks are high despite the low valuations. 4 to 5 percent growth is not enough for the country to catch up with the Western countries with high incomes, according to Strobaek.
Important information
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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