Source: Jin10 Data
Author: Kim Yiman

Despite being prepared, global investors still feel nervous, uncertain about the financial markets and global economy's reaction after the rate cut.

The Fed lags behind other central banks like the Bank of England, the European Central Bank, as well as the central banks of Canada, Mexico, Switzerland, and Sweden. They have already lowered interest rates to address economic slowdown and inflation. However, no one can influence the market like the Fed, the largest central bank globally.

Therefore, the interest rate cut is bound to shake every corner of the financial world.

Currencies, commodities, and markets at the forefront

Interest rate changes always affect currencies. Always have. Higher rates mean foreign investors can get better returns, thereby increasing the value of the relevant currency.

In the past few years, we have seen the US dollar surge, while Japan and Turkey have seen their currencies collapse due to low interest rates. The yen and the lira have been hit hard, but the US dollar has strengthened against a basket of global currencies, reaching a new high in 2022. The gap between the Fed's interest rates and those of other central banks has created friction.

You see, the stronger US dollar makes imports more expensive for countries with weaker currencies, pushing up their inflation rates. Central banks like Japan's are in a difficult position, trying to control inflation while keeping their currencies weak.

Although we saw on August 5th that the Bank of Japan may be as powerful as the Fed, as it single-handedly caused every financial market (including cryptocurrencies) to crash. Bitcoin fell below $0.05 million within seconds, marking the first time in months.

Then there's the US economy itself. Weakness in the labor market and concerns about a recession are lurking in the shadows. Traditionally, higher interest rates make gold less attractive, as bonds and other fixed-income investments offer better returns. But gold is also a hedge against inflation, and as rates decline, inflation could rise, increasing demand for gold.

Oil and other commodities usually priced in US dollars could also benefit from Fed rate cuts. Lower borrowing costs can stimulate economic activity and drive demand for these raw materials.

Developing and underdeveloped economies, in particular, are highly sensitive to US monetary policy. Any move by the Fed could hit them harder than large economies.

What about the stock market? It's not immune either. Wall Street has been on edge since last Friday, swinging with every piece of news about when and how much the rate cut will be.

Dalio's warning and major global powers

Prior to the interest rate decision, Ray Dalio, co-founder of Bridgewater Associates and a top player on Wall Street, listed three interconnected forces driving the global economy.

First: debt, currency, and economic cycles. It is well known that the United States holds a large amount of debt. Under the highest interest rates in 23 years, federal government spending on debt repayment alone reached $1.049 trillion. This is a 30% increase from last year, with the total expected to reach $1.158 trillion by 2024. Ray Dalio wonders how to manage this debt after interest rate cuts.

He also raises the issue of internal order and chaos in the United States. The upcoming election has revealed deep divisions, with Kamala Harris now seen as a stronger candidate than Donald Trump, according to a CNBC Federal Reserve survey. But apart from who will take office, Ray Dalio points out that the transfer of power itself could be chaotic, with a huge gap in wealth and values tearing the country apart. Internal political turmoil could in turn lead to more market instability.

The third force mentioned by Ray Dalio is the tension between major global powers. He warns that geopolitical conflicts between these superpowers can easily escalate. Frictions already exist in trade, tariffs, Ukraine, and Iran.

Meanwhile, the stock market may be preparing for disappointment. Last week, traders were anticipating a quarter-point interest rate cut. But now, the market is betting on a half-percentage point cut. This change has driven the S&P 500 Index and the Dow Jones Industrial Average to record highs.

The CME FedWatch tool shows that traders now give a 63% probability of a 50-basis point rate cut, bringing the current rate of 5.25%-5.50% down to the range of 4.75%-5%. The probability of a more moderate 25-basis point rate cut is 37%.

JP Morgan warns that if the Federal Reserve cuts rates by 50 basis points, it may calm the market by confirming expectations for aggressive rate cuts until December. But some analysts are worried that this may indicate deeper economic problems in the United States.

Historically, a 50-basis point interest rate cut has often led to lower stock market returns, as was the case during the Great Financial Crisis and the bursting of the dot-com bubble. There are strong reasons to support a faster pace of interest rate cuts, but there is a lot of uncertainty.

In addition, it is unusual for Jerome Powell and his team to keep the market in the dark so close to the next US presidential election. Due to differing opinions within the Federal Reserve Board, no one can predict which direction the decision will go.

Now all we can do is wait.

Editor/rice