Holly Black: Welcome to the Morningstar Series Market Reaction. I'm Holly Black. With me today is Ross Mould. He's Investment Director, AJ Bell. Hello.
Ross Mould: Hello, Holly. How are you?
Black: I'm good. So we're talking today about the US Federal Reserve, which has cut interest rates this week, for the first time in a decade. What's happened?
Mould: I think there are a couple of things that they're thinking about. One, they're clearly under an enormous amount of political pressure from a chap called, Donald Trump, who wants cheap money. It's where he comes from. He wants the economy to be buzzing, when he gets into a reelection fight in 2020.
The second thing the Fed is worrying about is global trade, which is partly, again the result of the President's policies, and he stepped up the tariff war with China virtually as we sit here today.
And the third thing they are worrying about is the U.S. economy, softening; the lagging data, unemployment, really strong; concurrent data, retail sales, industrial production factory orders, not bad. Lead indicators, softening, PMI survey. So you've got quite a mixed picture in the U.S economy, more mix than you perhaps might think from the stock market. So, looking at those three factors and Chair Powell has said, it's a sort of mid-cycle adjustments to make sure that the wheels stay on.
Black: So sometimes a rate cut comes before a recession. But this one seems a little bit different.
Mould: We'll find out and that's going to be one of the most interesting things is the stock market and the bond market latch on to this saying, Happy Days, more free, more cheap money, brilliant news, because if interest rates go down, that falters money out of cash, because it goes looking for a better return, stocks economic growth, good for corporate earnings, good for share prices. And that's what the stock market is thinking.
However, if the Fed is really frightened of a recession, the market may need to be careful what it wishes for, because in 2001 to 2003, 2007 to 2009, big Fed rate cuts did not stop a recession and did not stop a bear market. So yeah, maybe markets do need to be careful what they wish for.
Black: So the Fed put rates up four times last year, is it going to backpedal on that? Or is this a one-off?
Mould: Well, before Mr. Powell spoke, when he said mid-cycle adjustment, I'm not promising anything more. The market was actually forecasting four rate cuts over the next 12 months. He hasn't given them that bone to chew on. But what he did say was quantitative tightening. He's now stopping that two months early at the end of July, basically. So that is QE, the Fed's balance sheet went from $900 billion to $4.5 trillion, as it bought all these bonds, the depressed bond prices and trying to get credit flowing. It's now going to stop at about $3.5 trillion to $3.6 trillion. So, the Fed's balance sheet is never going back to where it came from. That money that it's created, is now going to stay with us, or the vast majority of it. And that's probably why gold is starting to run, because people are looking, thinking like, hang on a minute, (dwelled) this extra cash isn't going away, maybe when the next recession comes, they're going to go back to QE a lot quicker than – we didn't think they go back at all or maybe they will. And that's when people started thinking, maybe we need to protect ourselves a little bit from more Central Bank free and easy money.
Black: So the questions is, what does this mean for my investment portfolio?
Mould: I think it means a little bit of hedging on your currencies might not be a bad idea and I think it's interesting that gold has finally broken out of that $1360 range that it kept for five or six years. And I think probably, I would think at the moment, because the markets has been so excited about rate cuts, I'd actually be a little bit more careful. Because if the Fed really does think a recession is coming, stocks are going to look very expensive and there's lots of trouble ahead. If the Fed is going to keep on pumping and pumping and keep stocks going then fine, but I think when everybody is getting very, very excited, you probably needs to be a little bit more cautious.
Black: And lastly - does this mean the Bank of England is going to cut next?
Mould: If you look at the chart of U.S. interest rates against UK interest rates over the last say 25 years, where the Fed leads, the Bank of England is generally tended to follow, so it seems a fair bet. However, Mr. Carney this week, as usual, the Governor of Bank of England spoke on both sides of his mouth at the same time. He said that, well, we want to raise interest rates because wage growth is picking up, and the economy is okay, but we're very frightened of what Brexit could do, and if there's a hard Brexit, we may actually end up cutting interest rate. So, I think understandably, he's hedging his bets. But yeah, he didn't give anybody much guidance at all. But if I was forced to guess, I would say the next move will be down, not up.
Black: Thank you so much for your time.
Mould: Pleasure.
Black: And thank you for joining us.
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