This week in the markets: new high for shares as Fed cuts interest rate

In another quiet week on the corporate and economic front, investors continue to focus on last week’s pivotal move in US interest rates.

Fed opts for a jumbo cut

Cutting interest rates by 50 basis points was not without risk. After a year stuck at a 23-year high, opting for double helpings of monetary easing last week might have spooked markets, suggesting the Fed was more worried about growth than inflation and pointing to a looming recession.

As it happened, investors took chairman Powell at his word. The half percentage point cut was simply an attempt to catch up after a longer than expected wait to make sure that inflation was really under control. The US economy is in good shape, so the nascent rate-cutting cycle is different from previous eases, which have tended to accompany a slowing economy or recession.

The question now is how far can interest rates fall. Markets are pricing in a terminal rate of 3% or lower. The Fed is looking for slightly fewer cuts than this. Either way the direction of travel is clear. The cost of borrowing is falling and, against a backdrop of rising earnings, high but not excessive valuations, and a likely soft landing for the economy, investors have concluded that it’s safe to get back in the water.

More caution on this side of the pond

The Bank of England is plotting a more cautious path. Having beaten the Fed to it with a quarter point rate cut earlier in the summer, the Bank sat on its hands last week, leaving interest rates at 5%.

The problem here is that, while headline inflation is close to target at 2.2%, the key service side of the economy is experiencing much stronger price growth and wages are still rising too quickly. The Bank is unconvinced that the battle with inflation has been won just yet.

Meanwhile, on the continent, interest rates are falling as the engine room of the European economy in Germany splutters. Volkswagen shutting factories in its home market is just the most visible sign of an economy suffering from a slowdown in its main export markets and the end of the cheap energy on which its manufacturing strength has been built.

The (almost) everything rally

Falling interest rates are showing up as positives for most financial markets. Stocks hit a new all-time high the day after the Fed’s announcement, with Nasdaq up 2.5% and the Russell 2000 index also strong as tech stocks and smaller companies showed their sensitivity to cheaper borrowing costs. The S&P 500 rose above 5,700 and held there by the end of the week, nearly 1,000 points higher than it started the year, for a year-to-date return of almost 20%.

Meanwhile, gold broke above $2,600 an ounce as investors priced in a lower opportunity cost of holding a yield-less asset as interest rates fall. They are also enjoying gold’s traditional safe haven reputation at a time of heightened geo-political tensions. Gold has risen by more than 60% over the past two years, living up to its historic pattern - years of going nowhere followed by a surge higher.

One asset has gone the other way over the past two years, however. Oil has fallen from a high of nearly $130 a barrel in the wake of the Russian invasion of Ukraine in February 2022 to today’s level of not much more than $70 on the back of weak demand out of China and Europe, and weakening demand in the US. China, in particular, continues to be a massive disappointment, emerging much more slowly than hoped from the Covid pandemic and suffering from a lingering property slump that is feeding through into sub-par economic growth and faltering consumer confidence.

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