The US Federal Reserve lowered its key interest rate further last week. At the same time, purchases of short-dated government bonds were also announced. Both the lower interest rates and the higher liquidity have a positive effect on economic growth, which means that the measures should also support the stock market.
Note: Please note that an investment in securities entails risks in addition to the opportunities described. Prognoses are not a reliable indicator of future performance.
As expected and already anticipated by the market, the Fed’s monetary watchdogs made a further interest rate hike of 0.25 percentage points last Wednesday. The target corridor for the key interest rate is now 3.5 to 3.75%. This means that the Fed has already cut the key interest rate by 1.25 percentage points since September.
The central bank continues to face a challenging situation: Economic growth is on trend – the Fed is currently forecasting growth of 1.7% p.a. for the end of 2025. At the same time, inflation is above the long-term target of 2%. The Fed’s current estimate is 2.9% p.a. The unemployment rate is also trending slightly upwards and employment has been stagnating for months.
Increasing productivity through AI?
The estimates for next year are particularly interesting. Compared to the last publication last September, the forecast for economic growth has been revised significantly upwards from 1.8% to 2.3%. At the same time, the projection for the unemployment rate remained unchanged at 4.4%, while that for inflation was reduced from 2.6% to 2.4%.
Note: Prognoses are not a reliable indicator of future performance.
Even though these figures and forecasts may sound very technical, they have remarkable implications. This is because higher growth with a constant unemployment rate and lower inflation is only possible through an increase in productivity. The underlying assumption seems to be that strong investment in the field of artificial intelligence will lead to higher growth.
What interest rate policy should the central bank pursue against this backdrop? High interest rates so that inflation falls? That in turn could cause the unemployment rate to rise. Low interest rates to support the labor market? That could lead to an increase in inflation. Or the third option: neutral interest rates because the inflation and labor market risks balance each other out?
Since September 2024, the US Federal Reserve has opted to gradually move the key interest rate from restrictive to neutral. This follows the Fed’s view that inflation risks have decreased and labor market risks have increased.
Fed likely to adopt a wait-and-see approach
Opinions on the future shape of interest rate policy vary widely within the Interest Rate Committee, depending on whether greater emphasis is placed on inflation or the labor market. Some Fed central bankers are signaling an unchanged key interest rate next year, while others are calling for a sharp cut. The consensus is the core message delivered by Fed Chairman Powell: “The adjustments we have made to our monetary policy stance since September bring them [the key interest rates] into a range of plausible estimates of neutrality […]”. Translated, this means that the Fed has abandoned its official inclination to cut interest rates and is now adopting a wait-and-see approach.
The extent and timing of further adjustments will be determined by the economic data. In the immediate future, today, Tuesday, will be the focus of attention: the markets are eagerly awaiting the labor market figures for the month of November.
In addition to the interest rate cut, the Fed has also announced another measure. This month, the central bank will make purchases of short-dated government bonds to the tune of USD 40 billion – this measure may also apply for longer. The supply of liquidity on the money market is intended to cushion the pressure for rising money market interest rates. More central bank liquidity is fundamentally positive for the markets.
Conclusio
The further interest rate cut and the additional injection of liquidity are supporting the stock markets. At the same time, the US Federal Reserve continues to anticipate a positive economic environment next year. This should be positive for asset classes with a positive correlation to growth and inflation in the coming year, i.e., primarily equities, high-yield bonds, and gold.
Note: Please note that an investment in securities entails risks in addition to the opportunities described.
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