Key interest rate turnaround in the USA ahead – What does this mean for the markets?

BaaderBank: Even the sparrows are chirping it from the rooftops of the US Federal Reserve in Washington.

Starting in September, the Fed will begin its long-awaited interest rate cutting cycle.

Is everything now rosy on the capital markets?

If the Fed waits longer to cut interest rates, it will be high treason against the economy

America's industry is stuttering. And while the labor market is returning to pleasant reality after its happy hour, inflation continues to fall.

What speaks against interest rate cuts now? Nothing!

The Fed immediately prioritizes jobs over price stability.

Because the Fed knows that by the time the interest rate cuts reach the economy, it could already be in recession.

Jerome Powell did make verbal efforts to moderate his approach in order to make his upcoming interest rate turnaround appear more cautious.

He is the chief diplomat among all central bankers or – with all due respect – could one perhaps also call him Chief Silvertongue?

But it does not take an oracle from Delphi to know that the US interest rate policy reversal will begin on September 18.

And so financial markets are currently pricing in interest rate cuts at each of the next five Fed meetings.

Depending on how inflation and the labor market develop, cuts of up to 50 basis points are also possible.

Confirmation of the American interest rate cut twilight comes from the appliance market, where the US dollar is unusually weak against the euro.

Japan as a monetary policy spoilsport?

The Fed's interest rate hike is like the icing on the apple pie for the stock markets.

But the Japanese central bank is apparently leaving a bad aftertaste.

For many years it was the world’s liquidity machine.

No wonder, the low interest rates worldwide caused the yen to depreciate and made Japanese borrowings and investments in higher-yielding international asset classes a lucrative business.

On August 5, when the Tokyo central bank raised interest rates even minimally and thus increased the value of the yen, the end of the liquidity paradise seems to have been heralded for many investors.

But how realistic is this scenario?

The Japanese inflation rate has risen in recent months, which suggests that central bank interest rates will continue to rise.

But since Japan's national debt, several times its economic output, is so devastating that the Americans look cute in comparison, the urgent question must be asked how Japan will recoup higher financing costs.

The point of no return has long been reached.

Isn’t higher inflation even “desirable” in order to get rid of debt in a graceful manner?

America has mastered this practice for many decades, if you look at actual inflation, not official inflation. In this respect, neither an interest rate nor a yen revolution is to be expected in Japan.

How do the capital markets react?

Low interest rates increase the return on debt-financed investments. Credit-loving Americans can also get new money more cheaply.

Both increased corporate profits and thus filled the fundamental troughs of the stock markets.

Last but not least, interest rate markets close to money markets are losing their attractiveness compared to riskier stocks.

After all, the economic recovery resulting from interest rate cuts is creating lucrative price potential for corporate bonds.

Gold is also shining brighter as its disadvantage of not offering any ongoing interest is losing its negative weight.

And cryptos are also benefiting from the interest rate turnaround.

The Fed has a heart for small caps

Of course, interest rate cuts by the Fed are proof that the US economy is no longer running smoothly.

And indeed, the performance of US stocks from the second and third tier, which are particularly sensitive to economic trends, compared to the booming high-tech stocks has so far been like the fall of Rome.

But stock markets are not one-way streets, neither up nor down.

The small stocks are more dependent on financing and therefore react much more sensitively to interest rate cuts than the blue chips.

And obviously they are already putting on weight.

During the US reporting season for the second quarter of 2024, approximately 90 percent of the companies in the Russell 2000 were able to increase their profits by an average of almost 19 percent year-on-year, despite stagnating sales.

Your cost management is already working well.

How positively will the expected increase in sales have an impact on profits and margins when the Fed's economic stimulus program also kicks in?

A resumption of outperformance of small versus large is to be expected.

The Fed has paved the way for this. We investors should follow it.

Market commentary by Robert Halver, Baader Bank