With less than a week to go, the US election is fast approaching. The decision is likely to have a major impact on the world and financial markets. Both candidates are drumming up support wherever they can. With less than a week to go, no candidate has emerged as the clear winner. Instead, the race is very close and will be decided by the swing states, where the candidates are also very close. Interestingly, current Vice President Harris is leading the national polls, while ex-President Trump is leading the betting sites. Trump has also managed to regain a lot of ground after it looked like he was going to lose badly to Harris shortly after she entered the race. Although there is no clear winner yet, the race is currently boosting financial markets.
In particular, equities have resumed their rally after a weak summer and are back at record highs. Other factors, such as the hype around AI and strong earnings, particularly from technology companies, strongly supported the rally. More recently, the Fed's larger-than-expected rate cut has been a major contributor to the strong year for equities. On average, US election years also tend to be positive for equities. The technology-heavy S&P 500 and Nasdaq indices both rose by more than 20% for the year. The Dow Jones was up 15%, but has fallen back slightly and is currently up 12%. Small caps have struggled in the early part of the year, unable to match the gains of large caps. Nevertheless, the Russell 2000 Index is also up 10% before the latest surge. Figure 1 shows a comparison of the above indices through 2024.
After a difficult summer for equities, the months of September and October were generous to the global markets. US equities in particular have performed remarkably well. The biggest catalyst for these recent strong gains is the Fed's 50bps rate cut in September. The general view has also changed and further cuts, even large ones, are on the table and large rate cuts may be necessary. This has catapulted equity indices higher. The S&P 500 and Dow Jones Industrial Average continue to hit new highs on an almost daily basis. The S&P 500 surpassed 5,800 for the first time and nearly reached 5,900 in recent days. Similarly, the Dow Jones Industrial Average reached a new milestone by surpassing the 43,000 mark. Only the Nasdaq Composite has slightly missed its previous record high during these two months. However, the index is also very close to new record highs. Figure 1 shows the performance of the three indices throughout 2024. The Nasdaq Composite Index and the S&P 500 Index are both up nearly 25%, while the Dow Jones Industrial Average is up nearly 15%.
It has finally happened. The Fed cut rates for the first time since the unprecedented hikes began in 2022. Throughout 2024, hikes were expected at almost every meeting and investors were consistently disappointed. Initially, falling inflation was the main driver of these expectations. Once inflation fell below 4%, there was little further decline. Traders argued that inflation had come down significantly and was likely to continue to do so even with lower interest rates due to the usually lagged effects of central bank measures. Instead, the central bank moved much more cautiously and wanted to monitor inflation developments. At one point, inflation proved to be sticky and did not fall much below 3%. Occasional fears of recession reappeared, offset by a strong labour market. These recession fears began to rise as soon as the labour market started to weaken. In recent months, the focus has shifted away from inflation. Instead, the focus has been entirely on employment data. This culminated in the run-up to the September meeting, when a first rate cut was almost inevitable for the hesitant Fed. Given this caution, most market participants were expecting a 25bps cut, with a few predicting a 50bps cut. Surprisingly, the Fed did indeed cut by 50bps to 4.75%, with comments on further cuts in its two remaining decisions this year. Expectations for the federal funds rate at the end of 2024 now range from 4% to 4.25%. Figure 1 shows this in more detail. The Bank of England has also cut rates only once this year, in August, while the European Central Bank has already cut twice. Switzerland stands out, as its central bank has cut interest rates three times in 2024, with the first cut already in March 2024. Figure 2 shows the respective interest rates from January 2023 to September 2024.
The eyes of market participants are on the upcoming Fed decision this week. So far, the Fed has not cut rates, which is in stark contrast to what the markets had expected earlier in the year and throughout the year. Inflation, a key factor in the decision, is showing promising signs but remains sticky. The very low unemployment rate has so far led the Fed to no interest cut, as the economy is in an acceptable state despite inflation. However, the indicator is also starting to worsen. Unemployment has been steadily rising in 2024. This is certainly a worrying trend, but at 4.2% the unemployment rate is still very low by historical standards. Volatile equity markets are another threat to a potential recession. The Fed's policy balancing act is therefore crucial. It is now widely expected that the Fed will cut rates by 25bps at the upcoming meeting, with some forecasting a 50bps cut, although support for this view has waned since the August economic data. Based on current expectations, market participants are pricing in between 50bps and 100bps of rate cuts by the end of 2024. At this point, a 50bps cut seems more likely, with a cut this week and in December, when the Fed has had some time to monitor the impact of the first cut. On the more optimistic end, a 50bps cut is expected this week, with two 25bps cuts in the following two meetings. Figure 1 shows the federal funds rate throughout 2024 and where it could end up by December 2024. The Fed's rate cuts have also been discussed more prominently following the ECB's rate cut. The ECB has cut its deposit facility rate twice to 3.5% in 2024 from 4% at the beginning of the year. Inflation in Europe has shown similar stickiness to that in the US. In contrast to the US, this stickiness has been at lower levels, which helps the ECB to justify rate cuts. While inflation in the US has mostly been between 3% and 4%, inflation in Europe has mostly been between 2% and 3%. For Europe, market participants expect one or two more 25bps cuts by the end of 2024.
This would leave the ECB's deposit facility rate between 3.25% and 3%. This path is shown in Figure 2. |
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