Federal Reserve: Why is the US Fed going for a 50 basis point rate cut? Manish Singh explains

While most analysts held the view that the US economy was doing well, there is no recession At this point or even on the horizon, the consensus view was that a soft landing would occur with a 25 basis point cut. But now things have changed slightly in the run-up to the FOMC meeting. Haven’t they? A 50 basis point cut doesn’t seem entirely unlikely.
Manish Singh: No, it’s not unlikely and we’re going to get it and it’s justified. Because if you look at the two-year rate, the two-year Treasury yield is at 3.57% and the upper bound on the federal funds rate is 5.5%, so we’re talking about a spread of 190 basis points. You have to go back to 2008 to see a spread that wide.

Of course, at that time, we knew there was a crisis and we had 75 basis point cuts. Now, of course, we’re not going to have 75 basis point cuts because there’s no crisis going on. But the reason I think the Fed is going to cut 50 and why it should cut 50 is that if inflation is on track to be 2%, it’s at 2.5% now, what justifies rates being so restrictive? We’ve seen the fastest rate increase in the last 40 years. Rates have been at 5.25% for 14 months. What justifies them being at this high restrictive level? It doesn’t make sense. So I think for that reason we’re going to have a 50 basis point cut.

But what do the markets really want? As we launch the first rate-cut cycle in four years, the first since 2020, since the pandemic hit us, what is the best scenario for the economy? stock markets right now?
Manish Singh: Well, I would say it depends on who you ask. To me, 50 basis points is about right. The swings and the back and forth that you see in the market’s prediction of a 25- to 50-basis-point rate cut are simply due to the short-term trading and forward-looking behavior that you see in the rate market. That shouldn’t be a determining factor in whether it should be.

What the market is going to look for is that this 50 basis point cut is accompanied by a speech saying that it is the right thing to do, that rates are very restrictive, but not accompanied by the idea that we are trying to avoid a recession, which is not my best case scenario, because if we look at the leverage in the real estate market, which is at an all-time low, 27%.

Of course, the stock market is at an all-time high, and that creates a wealth effect. House prices have risen a lot in the last three or four years, which creates a wealth effect. You’re still earning 5% on deposits, so there’s an income effect. Ten percent of the U.S. deficit is managed at the federal level, and that’s going to go into spending and into the economy. So I don’t see a recession in the next six months.But what emerges from the comments is going to be crucial, isn’t it? What are the reasons you think they will give for a rate cut this time? Do you think they will say it’s because inflation is coming down or will they allude to some kind of recessionary tendency because any mention of the need to fight a recession could spook the markets?
Manish Singh: Yes, and I don’t think it needs to be mentioned, because if you look at the jobs report, we saw that the job openings to the number of unemployed have gone down from two to one, they’ve been cut in half. The total job openings are at 7.6 million, which is the pre-COVID level. In fact, if you look at the FOMC members’ own projection of where the unemployment rate should be by the end of this year, the unemployment rate is higher than that. So, there is a very genuine and good reason why they should cut rates by 50 basis points and the market should not panic because those conditions have been met and therefore the rate should come down.In addition to keeping prices under control, the Fed wants to ensure that employment levels are high and it seems that the Fed is trying to work more on employment than inflation. Would that be a correct reading at this point?
Manish Singh: Yes, the focus has shifted to jobs and the economy and it should shift to jobs. And if it wasn’t for the US election, which is the hot topic, and I don’t think they’re going to talk about it, then I think the rate cut would have started last July. The only thing the Fed is worried about is that depending on the outcome of that election, let’s say for example we think President Trump comes back and puts tariffs and inflation goes from 2.5% to 3% or 3.5%, then the Fed can’t cut rates, but that would just be the wrong decision and that’s the complication that they’re going to have to keep in mind as they (2:56) get through this FOMC meeting and the next one closer to the election.

So between September and the end of this calendar year, when of course the US elections should have taken place, how many rate cuts do you expect to happen? What do you think the amount of each cut will be?
Manish Singh: If you look at the projections and you can go by the SEB that we’ve had so far and various comments from FOMC members, 100 basis points by the end of this year, a cut by the end of this year, seems to be on the table. Whether it goes to 50, 25, 25 or 25, 50, 25 is a different question. But it boils down to that’s what the Fed is targeting, that’s what FOMC members are targeting. But if you look at the overall cycle, where rates might go, look at the two-year rate, the two-year rate has always been a good predictor of where the federal funds rate should eventually be and it’s 3.5.

So we are talking about a cut of at least 175 to 200 basis points in this cycle. That could happen in the next nine to 12 months, not necessarily in the next six months.

Interest rates go down in an economy, borrowing becomes cheaper. Households are more inclined to buy more goods and services and then businesses experience an increase in demand which causes them to seek to borrow more funds, expand their operations, perhaps build larger capacities with more equipment, etc. They invest in newer projects and then create more jobs and then wages also increase. Is that what you think is happening in the US economy?
Manish Singh: No, that’s probably what will happen. I find it very difficult to defend the idea of ​​a recession under the current circumstances. As I mentioned, the federal deficit is still between 8% and 10%. The deficit figure has reached a record high. If money is spent, there will not be a recession. The only problem is that there will be inflation because money supply It’s expanding and those things have been addressed in the sense that supplies have improved, the labor market is not as tight as it was in the past, so those things have been addressed.

So it’s very difficult to say that a recession is going to happen. What we’re really going to see is continued growth, which means stocks are going to go up.

Yes, but one of the factors that is moving is the outcome of the US presidential election. But this is a time when we are also seeing that the Chinese dragon is not breathing fire. In fact, quite the opposite, China is dealing with a housing crisis and its manufacturing output is slowing down. The stock markets are going to watch the US economy much more closely and will be affected by how the Federal Reserve makes its decisions.
Manish Singh: Well, that is certainly true, because the global market watches what the Fed does and what happens with the dollar, what happens with oil, and follows suit. But remember, a lot of things are about sentiment. It is easy to turn a bullish argument into a bearish argument just by using a different set of statistics. So, I would say not to focus too much on short-term market moves; we saw the yen carry trade unravel in August and then people started buying stocks again.

Actually, the Japanese yen is much stronger today than it was in August. From there, it went from 160 to 140, and today it is at 140. So, the yen is stronger and stocks are up. How do you explain that? So, it’s not just one or two data points as to how it impacts. So, I like to look at what’s happening in the next 6 to 12 months and based on that, I’m just not worried about where the recession or economic stagnation will come from.

On the contrary, if there is a deal between the US and China, which could happen after the elections, then there could be new growth.

But since you’re talking about currencies, normally the US dollar would weaken with a rate cut cycle and help other global currencies appreciate. Is that the case this time or do you think the dollar’s fall will be limited? Is this scenario different?
Manish Singh: I am not a currency expert and it is very difficult to set targets as to how things will play out, but I imagine that interest rate parity differentials will play a role and the dollar will weaken a bit.

Gold has a negative relationship with bond yields because most of the demand is for investment purposes and right now we are seeing gold at all-time highs. Do you think gold prices will rise with the Fed rate cuts?
Manish Singh: From what I have read, central banks, China and the Middle East are also buying gold. So if the buying is to build up reserves, then it does not matter where the rates are if the central bank decides to buy gold. It is difficult to say where they will be. But, as I have always maintained, gold is the ultimate insurance; it has a place in the portfolio, but not for reasons of profitability, but for reasons of insurance.