Fed signals it’s not afraid to act to bolster U.S. economy

September’s big rate cut is an indication of just how aggressive the Federal Reserve Board is prepared to be to keep the U.S. economy on an even footing, says Dustin Reid, vice-president and chief strategist, fixed income with Mackenzie Investments.

“The Fed seems to be signalling that if push comes to shove, it will be there,” he said. “It will not hold back in terms of doing a little bit more accommodation, providing a little bit more liquidity to the economy.”

After wrestling inflation with eleven successive rate hikes beginning on March 17, 2022, the Fed finally declared a measure of victory last month with a half-point rate cut.

“The Fed appears comfortable moving toward what it views as neutral [governance], which is neither providing accommodation nor being restrictive in terms of rates,” he said. “And I think that’s generally, relatively, good for investors.”

Reid said investors still need to weigh plenty of other considerations, including fiscal policy, geopolitics, valuations and investment flows.

“There are many, many things,” he said. “But from a monetary rates perspective, it doesn’t look like this Fed wants to get in the way of preventing easy financial conditions.”

He believes markets were not fully priced in for a 50-basis-point cut in September, so “there was bound to be either a miss on the downside or a miss on the upside.” Overall, however, markets reacted well to the Fed move.

“We’ve seen yields [move] broadly higher since the announcement. And we’ve seen risk do relatively well and equities [move] higher. Credit spreads have tightened. High-beta currencies have outperformed the U.S. dollar broadly,” he said. “So, with the [cut of] 50 basis points, I would say markets are performing as expected.”

He said the probability of a soft landing for the economy, after years of heightened inflation, has increased, and the Fed now appears to be turning its attention to the labour market.

The board will rely on a number of labour statistics, he said, most notably the Beveridge ratio, which is the percentage of job openings divided by the unemployment rate.

“Going into the pandemic — kind of the Goldilocks economy of 2019 — the Beveridge ratio was running between 1.1 and 1.3. So, you had, let’s call it, 1.2 jobs available for every person that was looking for a job,” he said.

In the after effects of the pandemic, the ratio climbed as high as 2.0 but has now fallen back to 1.1.

“This is why I think [U.S. Federal Reserve Board chairman Jerome Powell] said that further deterioration in the labour market would be quote-unquote unwelcome. It’s getting to the bottom end of the Goldilocks range,” Reid said.

Reid believes if the ratio continues to fall, 50-basis-point rate cuts could become the base case, as opposed to 25-basis-point cuts.

For the foreseeable future, the Fed will likely continue to be very data-driven, he said.

“The Powell-led Fed is generally known to be a lot more tilted towards surveys than previous Feds,” he said. “Data watching — and we’ve been very much in data-watching mode for the last year plus — is going to remain a thematic for investors in terms of the path of policy rates and the amount of risk appetite in the market, and how financial conditions will trade.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.