On Thursday’s Twin Transatlantic Rate Cuts

The “special relationship” between the US and UK is one of the most time-honoured entities in geopolitics, and it took a fun turn Thursday: The US Federal Reserve (Fed) and Bank of England (BoE) cut rates a quarter point each, on the same day.^[i] This rarely happens! The Fed usually announces monetary policy decisions on Wednesdays, whilst the BoE has historically done so on Thursdays, according to our observations. But the US election pushed the Fed’s November meeting back a day, so here we are. Twin rate cuts, no surprises and nothing earthshattering for stocks, in our view.

Our research suggests markets had long pencilled in these small cuts, and neither bank seems in the mood to defy expectations.^[ii] BoE Governor Andrew Bailey seemingly doesn’t want to rock the boat at a time when UK stock markets remain a bit nervous over last week’s Budget.^[iii] In the US, we think the Fed was probably always going to do whatever investors had pencilled in prior to Tuesday’s elections, lest it appear political with a shocking move right after the vote. Best save surprises for when things simmer down a bit, to the extent either institution thinks market-based projections are off kilter.

At any rate, we don’t think either decision is an economic or market gamechanger. Our research finds markets are forward-looking, and considering most observers we follow projected these moves, we think it is fair to say both were pre-priced eons ago. And as for the economies, both countries were growing just fine at higher rates, and inflation (broadly rising prices across the economy) has cooled back near their monetary policy institutions’ targets.^[iv] Neither needs lower rates, in our view, but we find slower inflation can give the latitude to do so.

We doubt it is major stimulus, too. We think rates mostly affect economies via their influence on lending. Banks borrow short term to fund longer-term loans, with the spread between the two a gauge of lending’s profitability. Cuts aim to lower funding costs, making bank lending more profitable and encouraging them to lend more easily. Yet in this cycle, banks’ funding costs in both nations were already well below benchmark overnight rates tied to ample deposits—in our view, the very reason interest rate hikes didn’t bite hard.^[v] And we doubt a quarter point influences banks’ decisions on whom to lend to. But would-be borrowers typically like lower rates, so even if this only boosts sentiment a smidge, we don’t think it is a bad thing.

More interesting, to us, are long rates. In both nations—and globally—long rates rose after the Fed cut rates for the first time in September.^[vi] We have seen a lot of chatter about politics driving this, what with last week’s Budget projecting increased debt issuance and commentators we follow suggesting President-elect Donald Trump will push up US deficits with vast tax cuts once in office. Perhaps these factors affected US and UK rate movement relative to other nations, but we don’t think they explain similar volatility in Canadian and Australian rates.^[vii] Or throughout Continental Europe.^[viii] More likely, to us, is that bond rates reflect the widely held view, in our experience, that rate cuts are stimulus and will breed faster growth and inflation—a point Bailey underscored yesterday, calling UK inflation “stickier” than first forecast.^[ix] We think this popular viewpoint overestimates rate cuts’ stimulative effects, but its proliferation in commentary we reviewed seemingly argues against much lower long rates for the time being.

So we wouldn’t read much into yields’ sizable drops yesterday.^[x] Mostly, they just undo volatility from earlier in the week. Maybe the effect lasts a little longer, maybe not. To us, it is all just a friendly reminder from markets that bonds can encounter sentiment-fuelled wiggles, too. Our research finds they have less expected volatility than stocks, overall and on average, but they aren’t immune to swinging emotions and traders’ occasional whims.

Overall, then, we think this week’s twin transatlantic rate cuts largely extend the status quo. Economies growing before the cuts are likely to continue growing. Markets that were doing fine before cuts will probably keep doing fine. We wish we could add that the world would get over its fascination with monetary policymakers when people see that not much has changed, but we have been doing this long enough to know better.