Is the U.S. in an easing cycle?

Lower-for-longer rates continue to be a monetary policy theme worldwide. In the last three weeks, the Bank of Korea lowered its key rate, while the Bank of Canada, the ECB and the Bank of Japan held theirs.

And on Wednesday, the Federal Reserve lowered the target range for the federal funds rate by 25 basis point to 2%-2.25%. (The Fed also decided to stop shrinking its balance sheet right away instead of waiting for the end of September.)

Despite the dovish global theme, expectations for another U.S. cut should be tempered.

While the Fed highlighted inflation, which is running below its 2% target, as a downside economic risk, and also cited trade uncertainties and a slowdown in global manufacturing, its base-case outlook calls for an economy that can eventually move inflation toward target and sustain low employment.

Thus, the main message from the Fed this week was that the cut was a “mid-cycle adjustment,” not the start of a rate-cutting cycle, said National Bank in an economics report. That message was “a cold shower to some more dovish market participants,” the report said.

Markets were pricing in a “much longer series of cuts,” said a CIBC World Markets report. “Equities won’t like this message,” it said, referring to the Fed’s adjustment rather than potential easing cycle. However, equities “might be happier if the Fed is right and the economy grows well enough to support gains in earnings in 2020,” the report said.

A report from Desjardins called the Fed’s message “a middle course, delivering the expected key rate cut while avoiding a clear promise on additional easing.”

Scotiabank Economics said in a report that the Fed’s communication on Wednesday disappointed expectations — which was likely appropriate.

“While I am not sold on the notion of easing,” wrote Derek Holt, vice-president and head of capital markets economics at Scotiabank, “I generally agree with what is a fairly deliberate attempt to push back on market pricing for Fed rate cuts. Markets and strategists were arguably going too far.”

Holt also pointed out that the Fed’s “neutral-hawkish” stance could be positive for trade woes. “Maybe the U.S. administration will begin to deliver more responsible trade policy goals absent a bigger security blanket [in the form of easing],” he said. (He added, “Or not”—likely a reference to the U.S. president’s brash style. Indeed, on Thursday afternoon, President Trump tweeted that the U.S. will apply a new tariff of 10% on about $300 billion worth of products from China on Sept. 1.)

Holt also said Scotiabank may have overshot its easing expectation of three forecasted rate cuts for the year, including Wednesday’s.

National Bank said it continues to forecast “only” one more rate cut this year “in line with our expectation of above-potential GDP growth in the U.S. this year (2.3%).”

If second-half growth averages near 1.25%, as CIBC expects, “that might be tame enough for one final further quarter point trimming in Q4 (likely October),” the bank’s report said.

CIBC added that a Fed cut in the fourth quarter could see the Bank of Canada cut in 2020 “if that proves necessary to push the Canadian dollar to levels more supportive for exports.”

Assuming that two cuts would result in an easing cycle, stocks could be set to outperform. Earlier this month in a blog post, Mike Archibald, associate portfolio manager at AGF Management Ltd., presented an analysis of returns in the year following the Fed’s first move in a rate-cutting cycle (the number of basis points constituting a rate-cutting cycle was left unmentioned).

In non-recession cases, the average forward one-year return for the Dow Jones Industrial Average was 24%, with particularly strong performance in the early post-cut months, Archibald said.

The S&P 500 index also performed well in non-recessionary cases, he said, led by non-resource, pro-cyclical sectors such as information technology, communications, healthcare and industrials.

For full details, read the reports from National Bank, CIBC, Desjardins, Scotiabank and AGF.

European banks make wealthy clients pay for holding cash

In a world of lower-for-longer rates, banks are struggling to maintain profitability, especially where rates are officially negative. For example, the three-month interest rate in the eurozone was –0.4% in the second quarter. In response to the challenge of negative rates, some banks are putting the squeeze on wealthy clients.

This week, the Financial Times reported that UBS Switzerland will levy a negative interest rate — 0.75% annually — on individual cash balances that exceed 2 million Swiss francs (US$2.4 million).

Several banks in Switzerland and the eurozone already pass the cost of negative rates on to corporations, but most large banks have refrained from doing so with individuals, FT said.

UBS’s main rival, Credit Suisse, has said it is also considering such a move.

Clients can avoid paying the interest by moving their millions into non-cash assets or into fiduciary call deposits, which are transferred to banks or entities outside Switzerland, FT said.

For full details, subscribers can read the FT report.