By Naomi Rovnick and Yoruk Bahceli
LONDON (Reuters) – Major global investors are on alert for sharp market volatility after a big U.S. interest rate cut sparked confusion over whether the market-dominating global economy will boom or slump, clouding the outlook for stocks, bonds and currencies around the world.
Global stocks hit record highs on Thursday, a day after the U.S. Federal Reserve cut borrowing costs by 50 basis points from a 23-year high, while the euro, the pound and currencies from Norway to Australia rose against the dollar. U.S. stocks rose after an initially muted response to the Fed’s rate cut.
But in one sign that the Fed’s rate cuts are making policymakers outside the United States nervous, the Bank of England held rates steady on Thursday, citing uncertainty over inflation and global demand.
Traders have cut their expectations for a UK rate cut and some money managers have warned that the Federal Reserve may add too much support to the already strong US economy, lifting global growth but also potentially pushing up commodity and consumer prices.
“I think it is likely that the Fed will cut interest rates significantly and the economy will accelerate,” said Trevor Greetham, head of multi-asset at Royal London.
“There may not be a lot of (global) rate cuts at that time,” he said, adding that he expected greater market volatility from now on.
“I see more turmoil, there are a lot of risks,” said Tim Drayson, head of economics at Legal & General Investment Management, referring to the possibility of a slowdown in the U.S. economy.
LGIM, Britain’s largest asset manager, is not taking a strong position on global stocks and bonds at the moment, he said.
Spacing?
Traders expect the federal funds rate to fall by 72 basis points this year and 195 basis points by October 2025.
They have cut their near-unanimous bets on a quarter-point UK rate cut in November to around 80% and see the European Central Bank as unlikely to cut rates next month, but investors have viewed such expectations as precarious.
These European interest-rate-setting institutions are grappling with slower growth than the United States, but rising inflation, and their policy and market trajectories are based on a scattershot of unpredictable scenarios for the U.S. economy.
Fidelity International portfolio manager Shamil Gohil said faltering growth in the US and UK could persuade the Bank of England to cut interest rates faster and boost UK government bonds.
But such positions were likely to fail given current expectations of further U.S. interest rate cuts, which have proven to be wrong, he said.
“This could be a scenario where all markets are selling,” he said, adding that overall he expected global market volatility to rise.
Gohil said his investment portfolio is defensive, with a preference for investment-grade corporate bonds.
The US Federal Reserve is intervening in an “overheated” economy with GDP growth at 3% and inflation still above target, warned Neil Mehta, portfolio manager at BlueBay Asset Management.
Core inflation in the euro zone is running just below 3%, and policymakers there are divided over whether to cut interest rates in the future after lowering borrowing costs in June and September.
But if the Fed continues its policies, further strength in the euro against the dollar would increase pressure on the European Central Bank by making exports less competitive, Greetham said.
Marcus Jennings, Fixed Income Strategist at Schroders (LON:) The dovish Federal Reserve, coupled with the weakness of the eurozone economy, said that
German bonds are becoming more attractive.
But investors cautioned that any outlook for global central banks would likely change if U.S. data altered views on what the Federal Reserve might do next.
“If we start to see a contraction in employment in the US, the Fed will become more aggressive. Then they will start to panic a little bit about what is happening. If employment starts to recover, that would indicate that policy is not quite as tight as they thought it would be,” said Dario Perkins, head of macroeconomics at TS Lombard.
A measure of implied volatility in the stock market fell to 16.6 on Thursday, well below its high of nearly 66 during market turmoil in early August due to a surprisingly weak U.S. jobs report and subsequent currency market volatility.
The MSCI World Index has gained more than 10% since the Aug. 5 tremor.
Market volatility could rise because stock market valuations suggest the U.S. economy will strengthen on the back of lower interest rates, but government bond pricing hints at a recession, said Sheldon MacDonald, chief investment officer at Marlboro.
If the Fed succeeds in preventing a recession, that would boost trades focused on central bank divergence, such as bets that a more dovish Bank of England would keep sterling strong against the dollar, said Ben Gutteridge, multi-asset manager at Invesco.
A slowdown in the US would weaken stocks and support bonds around the world, narrowing the gap between regional markets, he said.
“If you don’t want to lose your money, you have to deal with the Federal Reserve the right way.”
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