Something happened here in Washington on Wednesday that reminded us all just how important America is to global finance.
The US Federal Reserve’s Open Market Committee duly made no change to interest rates, as did the Bank of England, the European Central Bank and the Swiss National Bank the next day.
But what did change – the Fed’s projections for its interest rates next year – has galvanised the markets, and that has profound implications for all of us.
The Fed chairman, Jerome Powell, was cautious, as central bankers must be. He talked of the need to get inflation down to 2 per cent, warned about slower growth, said there was no consensus on when rate cuts might start and all that.
But he also acknowledged that rate cuts could begin before inflation got down to 2 per cent, and new quarterly projections from the committee signalled there were likely to be three cuts of a quarter of a percentage point next year.
Cautious: Fed chairman Jerome Powell acknowledged that rate cuts could begin before inflation got down to 2 per cent
The markets seem to think there will be four or five reductions, possibly starting as soon as March. This is just a set of numbers that may change, in fact almost certainly will. But the message was clear and had dramatic impact.
This projected fall in short-term rates was enough to punch down longer-term rates in stunning fashion, jack the Dow Jones index to an all-time high, and push the wider S&P 500 pretty close to it.
The most important interest rate in the world is the yield on ten-year US Treasury notes, for the rate at which the US government can borrow is the anchor for everyone else. In late October it touched 5 per cent. On Monday it was down to 4.25 per cent in anticipation that there might be some positive signal from the Fed.
Then on Wednesday, as the Fed news sank in, it plunged to just over 4 per cent, and by Friday it was trading at 3.9 per cent.
If the US government can borrow more cheaply so too can our Government, our companies and of course our home buyers.
Thus the yield on ten-year gilts – UK Government bonds – which hit 4.7 per cent back in October and was still at 4.25 per cent after Jeremy Hunt did his Autumn Statement last month, is now down to 3.75 per cent.
You can try to work out what that means for the Budget in spring.
On my very rough tally, the combination of the fall in the Government’s interest costs over the past three weeks plus the prospect of higher tax revenues from faster growth cuts another £25 billion off the deficit.
recollect all that stuff about the Chancellor having more ‘headroom’ for tax cuts in the Autumn Statement? Well, thanks to the events in Washington he will have a lot more still, come the Budget.
What is happening is that though the central banks are hesitating about cutting interest rates – given the mess they have made in allowing inflation to take off I can comprehend why – the financial markets are doing that job for them. Don’t expect UK mortgage rates to plunge next year, but if the Government’s borrowing cost has fallen by half a percentage point in the past four weeks, expect mortgages to refuse by a similar amount. And expect them to continue to ease off from the troubling levels of recent months as we advance into next year.
But what do lower bond yields do for US equities? That is the hot subject here, and since it has been US holdings that have rescued many British investors’ portfolios, a pretty salient one in the UK too.
As always happens in December, the ranks of equity strategists have been publishing their forecasts for 2024.
Last year, with a few exceptions, they were far too gloomy. Most thought that the market would advance sideways or fall. Now the Fed has given a encourage huge boost to the ‘Santa rally’ that I wrote about last week. That is already making their predictions for 2024 look a bit off-key.
Bloomberg did a survey of 518 analysts just ahead of the events last week. The median projection was that the S&P 500 would accomplish 4,808 by the end of 2024, and that the ten-year Treasury yield would fall to 3.8 per cent.
Well, we are just about there already. The S&P 500 closed at 4,719 on Friday and the ten-year yield was 3.9 per cent.
My scheme had been to try to acknowledge the main themes the analysts brought out and converse them, but I don’t think there is any point. What has happened in Washington has changed everything.
There are clouds as always, including the threat of a serious economic slowdown.
But for investors, job-seekers, home-buyers – and governments – it has been a good week.
