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Winners from the US rate cut

In this short video, James Klempster analyses the potential drivers of the decision to cut US rates and the asset classes that are likely to benefit the most.

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

Hello. It's Friday, the 20th of September. I thought we'd pause for a few moments and just reflect on what's been going on in markets this week. In our video last week, the debate was around whether the Fed would do 50 basis points or 25 basis points of cuts, rather than whether there would be a cut at all. It was a done deal that something would happen, and we saw it this week. As the week progressed, the probability of seeing that 50 basis point cut grew, and indeed that is what we saw. And it's been well received by markets. The S&P was up 1.7% yesterday and hit a new all-time high. It's been in the doldrums since July, which was the last peak it had. It's been drifting, a bit listless over the summer. But here we are now with the 39th all-time high over the course of 2024. And clearly when markets are on a run, and when they're doing well, you do get regular all-time highs beating the previous one. So you get large numbers of consecutive all-time highs as these returns compound up.

 

So the 50 basis point decision – what was going on there? There's three schools of thought, because it's unusual to see such a large move in the first cut. Traditionally, as we saw in the UK, you normally get a 25 basis point cut to start off with, unless the picture isn't a particularly rosy one. For example, the start of the pandemic was the sort of time where historically you would see a 50 basis point cut. And yet this one has been greeted fairly positively by markets.

 

Three arguments

 

So what's going on? Well, there's three possible arguments I think you can divine from everything you can read about it. The first one, and it's a bit of a circular one, is that the Federal Reserve cut 50 basis points because that's what the market expected. And the Federal Reserve essentially, tacitly didn't want to spook the markets. Now clearly that flies in the face of orthodoxy, which is classically 'don't fight the Fed', whereas clearly that approach would be more along the lines of 'don't fight the market'. The Federal Reserve is falling in line with the tune played by the market rather than the other way round, which would be historically pretty unusual. But you can see an argument for why the Federal Reserve wouldn't want to rock the boat at the moment. The second is that ultimately the Federal Reserve is looking forward a year or so, as monetary policy tends to take quite a long time to have a meaningful effect, looking forward a year and forecasting with lots of data and tools available that we don't have, and essentially presuming there is a less rosy picture out there a year from now.

 

So the Federal Reserve is starting to cut more aggressively perhaps than you otherwise would, to try and get ahead of the curve and prevent that hard halt that we talked about again in the video last week. The third option is the sort of narrative that the Federal Reserve wants us to take on board, which is that in essence, inflation is down pretty substantially, which it clearly is. Employment is fine, the economy's fine, so we might as well cut 50 because the inflationary problem is largely behind us. Jay Powell made comments to that effect to say we think the economy's all right, we want to keep it that way, so we might as well cut 50 basis points. The reality is possibly there's a germ of truth in all those three. We will only ever know the reality of course with the benefit of hindsight. In the future we will be very easily able to pick over the bones and decide what the reality is. But as ever, as investors in the here and now, we're faced with uncertainty, not peril necessarily, not deep uncertainty, but of course uncertainty as a common and, in fact, a constant when it comes to investment management.

 

Three markets that could do well

 

So what can we do to ride out this uncertainty? Well, we rely on two of our regular friends that we mention in these videos, diversification and valuations. And thinking about some of the markets in a diversified suite that's available to us and that could do well from a cut in US interest rates – we have Asia ex-Japan and emerging market equities and US smaller companies. So going through those three in turn: Asia ex-Japan and emerging markets, a lot of the debt issued by those businesses is in hard currency. Hard currencies are often, in fact more often than not, US dollars as the world's reserve currency, and whether it be financing or servicing that debt on an ongoing basis, if those interest rates come down, it's cheaper to issue new debt. But also of course, if you're having to fund it in dollars, a lower interest rate tends to lead to a weaker currency, which makes it easier for those businesses to afford those dollars as well. On the smaller companies side of things, again on the finance side, they often have a fair amount of debt in their business, often at floating rates. A reduction in prevailing interest rates should make servicing that debt easier. At the same time, as we've talked about before, smaller companies tend to be more sensitive to the domestic economic situation. So a reduction in interest rates should improve the picture for consumers. It's easier for them to service their mortgages, for example, if they're floating rates. And again, that should increase their propensity to consume and that should benefit smaller companies as well. So a couple of examples of asset classes, or a few examples of asset classes that we have scored as four out of five on our metrics, not only because of their valuation, but also we think they are well positioned for the environment we are in now, which is that rate-cutting cycle.

 

BoE held rates

 

Elsewhere in the world, the Bank of England kept the base rate in the UK flat. It didn't move following the 25 basis point last time. So we're already in a position where the Fed's done one move, the Bank of England has done one move and the Fed's cutting cycle is already more aggressive than the UK. It doesn't necessarily mean very much. The Bank of England has said it's fine to leave it as it is, and it is setting a tone in its comments that is a bit more hawkish. It is a bit more nervous around the persistency of elements of inflation, whereas the Federal Reserve seems to be a bit more relaxed about that. We had some data from the UK this week about consumer confidence, which is as low as it was in January this year. It slumped down a little bit, following a better period over the earlier half of this year. If you remember at the start of this year, the UK was in a technical recession. And the argument is that the new government is laying the foundations for a tough budget in the autumn, which has weighed on sentiment. And it's a nice example of how rhetoric not only impacts markets and creates noise and volatility in markets, it can also spill over into the real economy. We just need to be mindful that we don't need to talk ourselves into recession, which is a possibility if the mood music, if the nature of the news flow is universally negative. People can respond to that by tightening their belts even if they don't individually need to. It's a reasonable response to a picture being painted for you.

 

That's it from me. Have a good weekend when you get there and we'll see you next time.

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KEY RISKS

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

The Funds and Model Portfolios managed by the Multi-Asset Team may be exposed to the following risks: 

Credit Risk: There is a risk that an investment will fail to make required payments and this may reduce the income paid to the fund, or its capital value. The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay; Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss; Liquidity Risk: If underlying funds suspend or defer the payment of redemption proceeds, the Fund's ability to meet redemption requests may also be affected; Interest Rate Risk: Fluctuations in interest rates may affect the value of the Fund and your investment. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; Derivatives Risk: Some of the underlying funds may invest in derivatives, which can, in some circumstances, create wider fluctuations in their prices over time; Emerging Markets: The Fund may invest in less economically developed markets (emerging markets) which can involve greater risks than well developed economies; Currency Risk: The Fund invests in overseas markets and the value of the Fund may fall or rise as a result of changes in exchange rates. Index Tracking Risk: The performance of any passive funds used may not exactly track that of their Indices. Any performance shown in respect of the Model Portfolios are periodically restructured and/or rebalanced. Actual returns may vary from the model returns.

The risks detailed above are reflective of the full range of Funds managed by the Multi-Asset Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.

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This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.

James Klempster
James Klempster James Klempster has 20 years’ investment management experience. Before joining Liontrust in 2021, James was Director of Investment Management at Momentum Global Investment Management. He has also worked for Avebury Asset Management and NW Brown Investment Management.

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