BOJ's Cat and Mouse Game

The Fed’s decisive 0.50% rate cut spurred risk appetite, leading to tighter credit spreads. US Treasuries lagged behind German Bunds, with the US yield curve steepening further due to higher 10-year yields. In the US, the S&P 500 surged to a new high, and the rate-sensitive Russell 2000 index also performed well. The FOMC’s median interest rate expectations for 2024 and 2025 has now been reduced by 0.75%.

Japan’s Nikkei 225 was buoyed by a weaker yen as the BoJ maintained its policy amid uncertainties. In emerging markets, Hong Kong’s Hang Seng outperformed during a holiday-shortened week, whereas Brazil’s Bovespa index declined as the Banco de Brasil increased rates by 0.25%. In commodities, escalating geopolitical tensions drove oil prices higher. Gold hit an all-time high amidst the market uncertainties.

In a move widely expected by many, The Bank of Japan (BoJ) kept its policy rate steady at 0.25% during its September meeting. Despite ongoing market volatility following the July rate hike, monetary officials maintain that the Japanese economy is generally in line with the Board’s projections from the July meeting. BoJ Governor Ueda highlighted that external uncertainties remain significant and that the risks of rising prices have lessened, allowing the central bank time to consider future policy adjustments. The adjustment in USD-JPY and the narrowing US-Japanese yield differentials seem to be settled for now.

Chinese authorities are drafting a proposal to relax home purchase cooling measures for non-local buyers in major cities like Beijing and Shanghai. President Xi recently reiterated China's commitment to achieving its annual economic and social development goals, indicating more policy support in the coming months amid uneven economic data and persistent growth challenges. The FOMC's recent 50bp rate cut provides the PBoC with more flexibility to support the markets and economy.

With the market anticipating a high probability of a significant rate cut, the Fed decided to be bold and implement a 0.50% move at its September meeting. This decision reflected greater confidence that inflation is now behind us, and it is time for the Fed to focus on maximizing the chances of a soft landing. If achieved, the soft landing would be beneficial for risk assets. Globally, equities typically perform well in the year following the first Fed rate cut, provided the US economy avoids a recession. The strategy for a soft landing involves a ‘great rotation’ in markets, with value, small caps, and emerging markets outperforming while Treasury yields drift lower, the yield curve ‘structurally steepens,’ and the USD weakens.

However, while the Fed has started a cutting cycle, policy is likely to remain restrictive for some time. Combined with the current cooling trend in the labor market, this means recession risk could stay elevated heading into 2025. Additional sources of risk, such as election uncertainty or geopolitical stress, can also come into play. There could be a more volatile phase for investment markets. And if the anticipated soft landing turns into a hard landing, risk assets will struggle even if the Fed loosens policy more than currently expected.

In September, the European Central Bank (ECB) cut rates again, and the Federal Reserve (Fed) delivered a significant half-point cut, but the Bank of England (BoE) kept rates steady. It is worth noting that divided opinions about the appropriate pace of easing are evident. With this in mind, the FX market is likely to remain sensitive to upcoming data releases to find clues for future policy paths and the global growth outlook. Beyond this, risk appetite has become a more dominant FX driver. As US election uncertainty is set to loom large over the coming weeks, the USD may find some support.

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Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Maiden Capital. The information provided is meant as a general guide only and should not be construed as investment advice. You should always consult your financial, legal and tax advisers regarding private equity and real estate investments