Central Bank Watch - Aug 2024

United States

The US Federal Reserve held the benchmark interest rate steady at 5.50% at its meeting yesterday. This was widely anticipated by the market which expects the Fed to cut rates by 0.25% at its meeting in September of this year. The markets welcomed this news as the stock market rallied on Wednesday and interest rates fell across the curve. Fed Chair Powell noted today,

“The broad sense of the committee is that the economy is moving closer to the point at which it would be appropriate to reduce our policy rate,”

With federal debt hitting $35 trillion in July and lots of bonds to sell, lowering interest rates would clearly reduce the government’s interest bill. The market reacted negatively to a 10-year US Treasury bond approaching 5% in October of 2023. The 10-yr currently sits around 4%. The 2-yr Treasury is 4.25% meaning the yield curve remains “inverted” when yields are higher on the short-end. The inverted yield curve can’t exist for a long period with so many financial institutions geared towards borrowing short and lending long. With other major central banks cutting rates and inflation moderating, the Fed has ample room to cut rates. What will happen to the yield curve over the next couple of years? This is very hard to predict. For the short end of the curve, it appears the market believes multiple cuts are ahead. According to the CME Group, the market expects short-term interest rates in the 3.00% - 3.75% range in September 2025. This would be upwards of 8-10 cuts of 0.25%. This seems like a lot of interest rate cuts with an economy humming along quite nicely. I wouldn’t be surprised if the market is getting ahead of itself again.

Global Central Banks

Central banks in China, Europe, the UK, Canada, and Switzerland have all lowered their benchmark target rate this year. With high debt levels in many G20 sovereign countries, many central banks have welcomed lower year-over-year price inflation readings as a reason to begin to lower interest rates. 

China, the second largest economy in the world, has suffered from a massive real estate bust in recent years. The benchmark Hong Kong Stock Exchange is down 40% over the past 5 years, see Figure 1 below. This has created a deflationary environment in China with inflation near 0% and GDP growth slowing. In a surprise announcement on Monday, July 22, the People’s Bank of China announced an interest rate cut for both short-term rates and five-year interest rates. The short-term rate is now 3.35%.

Figure 1: Hang Seng Index & FXI 5-year Total Return

Source: TradingView

References

• China cuts short and long-term rates. (2024, July 22). Reuters. https://www.reuters.com/world/china/china-cuts-short-long-term-rates-2024-07-22/
• FedWatch Tool. CME Group. https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

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