Monetary Policy Changes

The Fed has taken a significant step by officially initiating its cutting cycle, which holds profound implications for the financial world. ⚠️The #FOMC has cut the FFR by 50 Basis Points to a 4.75%-5% Range. ⚠️The latest projection of the Neutral Rate, R*, came in at 2.8% versus the previous estimation of 2.9% A cutting cycle might affect other central banks' stance on monetary policy because the US Dollar could devalue considerably going into 2025, making exports from other countries like Japan more expensive. For the past two weeks, business media has made a huge story out of a 25—or 50-basis point cut, but in my opinion, today's decision on the magnitude of the cut is meaningless. Financial conditions have eased considerably since July, so it should not be a surprise that the US economy might have already started to re-accelerate. The Atlanta Fed GDPNow is flashing a Real Growth Rate of 3% for the US Economy. If that materializes, it would mean that the US #Economy is already running 1% above its potential. Why financial conditions have already started to ease? Here are some examples: ✍️Mortgage Rates decreased from 7% in July to 6.15% today ✍️The 2-Year Yield decreased from 4.75% in July to 3.63% today ✍️The 5-Year Yield decreased from 4.06% in July to 3.47% today ✍️Housing Starts have picked up momentum What market participants have priced out is a resurgence of inflation during 2025. That scenario is entirely possible if the Dollar Index drops below 100. A cheaper dollar will make commodities and import prices more expensive for the US consumer, and a reduction in real income could squeeze even more of the low to middle class into the USA. Considering the decrease in US Treasuries for the past two months, I find US Government Bonds expensive across the yield curve at these levels. I think R* is well above what the Fed estimates because of factors like de-globalization, the reshoring of strategic industries, and increased protectionism. The terminal rate post-pandemic is between 3.5% and 4%, in my opinion, and that is where I think this cutting cycle will end. If I am proven right, bond investors must reprice government bond yields higher. How do we play a potential increase in inflation in a no-landing scenario? I tilted my portfolio as I outline here below: 👉Tilt the portfolio to over-weight energy and miners. 👉Have a marginal exposure to Gold and Silver. 👉Favor TIPs over US Treasuries 👉Increase allocation to US Value Stocks and International Stocks. 👉Lock-In US Investment Grade Credit at the belly of the yield curve where we can still get 4.8% to 5% yields, especially on issues at the Single-A Rating Enjoy the ride! #Finance #InterestRates #Economy #Investing

Here is a key macro indicator almost nobody is talking about. Debt service ratios (DSR) measure the amount of disposable income which is used by non-financial corporations and households to service their outstanding debt payments. In other words: how much of your salary is spent to cover your credit card and mortgage debt, or how much of corporate earnings are used to pay interest (and eventually principal) on outstanding loans and bonds. This is a crucial metric because it efficiently visualizes the pass-through of monetary policy tightening on the private sector. After all, the process by which raising interest rates is supposed to slow the economy works as follows: 1) Higher interest rates increase the borrowing cost for the private sector; 2) As a result, households and corporates slow down spending, hiring and consumption; 3) Ultimately, that's how the economy does what Central Bankers wanted when they started hiking: it slows down. Increasing debt service ratios (DSR) are a key indicator that the private sector is getting hurt by higher interest rates, and therefore that the economy might soon be slowing down. So: where are we today with debt service ratios? I looked at some of the major economies in the world and found that: - Australia, Canada, China, Korea, Norway and Sweden are under pressure Their DSRs are high in absolute terms and higher than their 20-year average, and the trend is also negative as they keep increasing over time. Unsurprisingly, these economies are already struggling a bit. - Europe and the UK are having a very slow pass-through so far Although that might change soon given the refinancing cliffs in Europe and the nature of the mortgage market in the UK - In the US, the big Fed hiking cycle has so far led only to a modest increase in the debt service ratio The US DSR increased to 15% (the US historical norm) with a very mild ongoing negative trend: households and corporates were smart to lock in low rates for long, and so the pass-through of Fed hikes has been quite slow so far. Keep monitoring the Debt Service Ratios: a key macro variable almost nobody is talking about, yet one which could give important indications about where different economies are going. Which economies do you think are the most exposed here? P.S. Enjoyed this macro analysis? Follow me (Alfonso Peccatiello) so you don't miss any post and stay updated on the launch of my Macro Hedge Fund! P.P.S. FREE TRIAL to my Institutional Macro Research? Join the biggest institutional investors in the world reading it every day - send me a DM and I'll set you up!

Last week, I presented my new paper "Reaching for Beta" at the European Central Bank. In the paper, which is joint work with Altan Pazarbasi from Bilkent University and Egemen Genc from University of Illinois Chicago, we document a new channel of monetary policy on risk-taking in financial markets. Specifically, we show that 𝗨.𝗦. 𝗲𝗾𝘂𝗶𝘁𝘆 𝗺𝘂𝘁𝘂𝗮𝗹 𝗳𝘂𝗻𝗱 𝗺𝗮𝗻𝗮𝗴𝗲𝗿𝘀 𝗮𝗰𝘁𝗶𝘃𝗲𝗹𝘆 𝗶𝗻𝗰𝗿𝗲𝗮𝘀𝗲 𝘁𝗵𝗲 𝗺𝗮𝗿𝗸𝗲𝘁 𝗯𝗲𝘁𝗮 𝗼𝗳 𝘁𝗵𝗲𝗶𝗿 𝗽𝗼𝗿𝘁𝗳𝗼𝗹𝗶𝗼𝘀 𝘄𝗵𝗲𝗻 𝘁𝗵𝗲 𝗙𝗲𝗱 𝘁𝗶𝗴𝗵𝘁𝗲𝗻𝘀 𝗽𝗼𝗹𝗶𝗰𝘆 and short term interest rates rise. This "reaching for beta" is persistent and leads to net buying pressure of riskier, high-beta stocks for several quarters. As a result, the prices of these stocks are temporarily bid up following a hike in rates. As equity mutual fund managers take on more risk when interest rates rise, reaching for beta is in stark contrast to other types of risk-taking that the literature has documented in the context of low or falling rates, such as "reaching-for-yield" or "reaching-for-income". Why do fund managers engage in this type of risk-taking? Our preferred explanation is that they seek to boost returns to prevent outflows into risk-free alternative investments such as money market funds when short rates rise. Indeed, we find that funds which reach for beta more see net inflows when monetary policy is tight and deliver higher raw, but not risk-adjusted returns, to their clients. Listen to an entertaining AI-generated ten-minute podcast about our paper here 👇 https://lnkd.in/e2KJ6dSM If you want to see the details of our analysis, you can find the paper here: https://lnkd.in/eCtRQHWT #monetarypolicy #stockmarket #mutualfunds #investorbehavior

In a recent study, we analyse 145,000 point estimates and confidence bounds on the effects of monetary policy shocks on output and inflation collected from more than 400 primary studies. We show that interest rate hikes by central banks are less effective in reducing inflation than conventional wisdom suggests. Correcting for publication bias, the output cost of reducing inflation increases. Our results suggest that we need realistic expectations about what monetary policy can achieve in steering inflation - and a broader mix of policy instruments, including fiscal, industrial, and competition policies, to ensure price stability at a reasonable macroeconomic cost. Policy brief in English: https://lnkd.in/dSJfrzu2 Policy brief in German: https://lnkd.in/dCATquGS Full study: https://lnkd.in/dBjXWVQ8

Focus shifting from inflation to growth? Price action since Friday afternoon - front end yields lower and equites lower (circled) - is being pointed to as evidence, but that's too simplistic. The bigger picture is trade-offs facing central banks are becoming quite impossible now: ➡️ In this supercharged ‘world shaped by #supply’ and inflation still above target, it will be much harder for central banks to make the case that they can look through the shock, particularly after having lost control of inflation during the Covid-19 supply shock. ➡️ If oil prices do not decline soon, we believe the key question shifts from "will central banks be able to cut?" to "will their policy rates keep up with the rise in inflation?" If they don't, it means the #real interest rates - which account for inflation - will be lower, easing financial conditions instead of tightening them. ➡️ But it's not clear if central banks will hike interest rates enough to keep real rates in restrictive territory. Concerns about government #debt servicing costs could also limit how far interest rates rise.

As expected, the Fed cut rates by 25 basis points and announced an end to quantitative tightening—both steps toward further easing. However, the meeting revealed some notable divisions within the Federal Open Market Committee. One member voted against the rate cut, while another favored a larger, 50 basis point cut. This dissent was a bit unexpected. Chair Powell also highlighted strong differences of opinion about a potential December rate cut and discussed the “neutral rate”—the level at which the Fed is neither stimulating nor restraining the economy. Powell suggested a range between 3 and 4%, higher than the 3% median estimate from FOMC members. These factors led markets to pause and reassess the likelihood and pace of future rate cuts. While markets still anticipate a December cut, the path ahead may be shallower than previously expected. Both stock and bond markets reacted with caution. For investors, this complexity is a sign that the Fed is weighing risks carefully—balancing the dangers of being too easy or too tough in today’s environment.  

The Fed lowered Fed Funds today by 50 bps to 5.0%. 11 of the 12 Fed governors backed the idea. They also shared their quarterly projections, targeting another 25 bps cut in November and 25 bps in December. So, if that holds, by year-end, we will have a 4.5% Fed Funds. For perspective, cutting rates usually is done to provide some financial relief in a struggling economic environment. The S&P 500 hit another record high on the news. The Fed policy statement said: "The committee has gained greater confidence that inflation is moving sustainably toward 2%, and judges that the risks to achieving its employment and inflation goals are roughly in balance." The 10y UST was at 3.64% on the news, up slightly from a 52-week low earlier this week. When the long end drops it can be a bearish signal as people are buying more bonds as a safety investment, pushing down rates. So you have the bond market signaling recession while the stock market is signaling that all is well. What a moment. I must admit I have a hard time reading the tea leaves on this one. Why did they cut 50 and not 25? Perhaps they know something I don't (and go ahead, make a joke, I'm an easy target!). Perhaps they are worried about the interest payments being the 2nd biggest line item in the Federal budget. But seriously, a 50 bps cut feels to me like a crisis cut. This is a policy change moment, to be sure. We all knew it was coming because Powell telegraphed it for months, especially at Jackson Hole. But the economy is doing very well, and top-line macro indicators look good. It is two months before a major presidential election where the incumbent is out of the race. To the point about inflation being subdued, I would be remiss if I didn't point out that housing prices are up 6.7% YoY as of August, which, granted, is lower than previous prints, but is still well elevated. Housing prices are the biggest component of the Core CPI. We are all living with the consequences of astronomical increases in housing prices. Perhaps the Fed thinks that by lowering Fed Funds this much, it could jump-start supply in the housing market, bringing people off the sidelines to sell, and to buy, potentially lowering prices as an equilibrium is found. I don't know. With this move we should expect to see a mini-boom for gold prices. Gold started the year at $2000, and now it's $2600 an ounce - a 30% increase YTD. The "barbarous relic" has for thousands of years been a safe-haven investment. Could be a driver of its bid. I'll have more to say about this move in the coming days. Need to think about it. But I am surprised they cut 50 and not 25. #fedpolicy #riskmanagement #interestrates

The Reserve Bank of India’s bold move to slash the repo rate by 50 basis points to 5.5%—its third consecutive cut this year—signals an aggressive pivot toward growth stimulation amid easing inflationary pressures. With food inflation softening and core inflation expected to remain benign, the RBI seized the opportunity to front-load monetary easing. The change in policy stance from “accommodative” to “neutral” reflects a recalibrated strategy: while liquidity support continues, the RBI is preparing to remain flexible should inflationary threats re-emerge. The simultaneous reduction in the Cash Reserve Ratio, expected to release ₹2.5 lakh crore into the system, reinforces the central bank’s intent to amplify credit flow and investment activity across sectors. This decision has wide-reaching consequences. Borrowers, especially in the housing and auto sectors, will see substantial relief through reduced EMIs—potentially saving thousands monthly—spurring consumer sentiment and retail spending. On the flip side, fixed deposit investors are already feeling the pinch of falling returns, a trade-off the RBI seems willing to make for broader economic revival. Stock markets have cheered the move, with the Nifty and Sensex posting gains as financials and real estate stocks surged. The message from RBI is clear: with inflation under control and global headwinds persisting, India is choosing to bet on domestic demand, and this rate cut is a calculated push to accelerate the country’s growth engine while keeping inflation in check. #LinkedinNews #Finance #RBI #SanjayMalhotra #MPC #RepoRate

So, finally we saw a rate cut by Fed yesterday. 50 bps it is. 🕺 Indian and remaining Asian markets today took it positively and they are up. 🚀 ⁉ What is a rate cut and how does it impact markets? Also, how does it impact economies? 😨 When in 2020, Covid struck and lockdown happened, most of us, including experts, thought this is going to be a massive recession, never seen before. 😭 People were losing jobs, economy came to a standstill. So what could the Government do? What could the Central Banks do? 💸 Infuse liquidity. Have people more money. Have companies more money (whenever they may resume operations). 💲 We have seen multiple times that a liquidity infusion has been taken as highly positive for markets. However, this Covid time? Personally, I was apprehensive initially. How can more money in the system help people come out of a healthscare? 😊 Well, we overcame all that. Too much cheaper money also helped companies and employees to a certain extent. 🤯 But there's always a downside of things. Cheaper money and more liquidity leads to high inflation. 💹 So if everyone has a lot of money but there are only limited goods, people will be willing to pay more, thereby, prices increase. ⚖ Central banks are always battling around balancing growth (increase liquidity to increase growth) and inflation (decrease liquidity to decrease inflation). ℹ So, US apparently experienced lot of money in the system pushed in 2 years (Feb 2020 to Feb 2022), that they then started increasing rates, which is opposite of what we discussed above. 😑 Increasing rates, means sucking out liquidity. Which means controlling inflation at the cost of growth. 😱 And US created a kind of history. In 1.5 years, they took rates from 0.25% to 5.5%. From US angle, as a developed economy, it's steep. It came too close to a developing economy of India. 😏 For past 1 year, there have been expectations of rate cuts. Every Fed meeting, people thought now might be the time. 🕺 And it finally came. 🙆♂️ Now there was a tussle between few people expecting 0.25% cut and few 0.50%. 👍 Expectations are already factored in markets. And likely this time, 0.25% was surely baked in. 😍 Not many would have expected 0.50% along with more cuts announced in coming months. This may have come as a surprise. 💹 With rates going down, both equity and debt markets experience a rise. Cheaper funds give more money to people, and many might start investing and companies might take cheaper loans to increase growth. ✔ Now, Asian and Indian markets are expecting that their economies will follow suit, sooner than later, and hence "factoring" in the expectations, hence markets rising. 🙄 Why did US market fall eventually yesterday? Profit booking may be. Can happen in India also. Keep a watch.

The Federal Reserve made its first rate cut in four years 50 basis points, marking the start of a rate cut cycle. The Fed expects to end 2024 at 4.4% and reach the terminal rate by 2025, which we estimate to be around 3.25%. This opens the door for the Bank of Canada to a wider range of options. Up north in Canada, inflation has returned to 2% half a year ahead of expectations. The pace at which inflation returned to target means the Bank could consider speeding up as well with a 50 basis point cut in October, given rising unemployment and slow business investments. The Consumer Price Index excluding shelter in Canada is 0.5%, nearly deflationary and way below pre-pandemic levels when policy rates were under 2%. This is one reason why the past three rate cuts have not moved hiring and consumer spending: at 4.25%, the policy rate remains too restrictive. Excluding mortgage interest payments, CPI is at 1.2%. As interest rates drop, CPI will likely continue easing. The Bank might have held restrictive rates for too long, now that price stability has been achieved, it’s time to pivot and look at how monetary policy can support employment and growth.