Markets are bracing for a central bank bonanza – and a Fed cut that’s been long in the making. Equities are already celebrating with US stocks at record highs while bonds are riding expectations that easier policy will cushion a cooling US labour market. But beyond Wednesday’s decision, the key question looms: what comes next?
The risk is that the Fed’s punchbowl for risk assets comes with a hangover. A cautious signal, or penciling in fewer cuts than markets are pricing, could shake the risk rally. And with other central banks moving in opposite directions, the real story for global investors may lie in policy divergence – not just the Fed.
Could the Fed spoil the party?
Chair Powell’s Jackson Hole nod to a weaker jobs backdrop opened the door to a September rate cut, yet August’s upside surprise in core goods inflation gives the Fed less room to move fast. With six cuts priced over the next year, the real story is not the size of the move this week, but how Powell frames the path. A hawkish cut – one paired with fewer dots in the dot plot than market bets, for example – risks deflating the risk rally in the near-term. Consensus is divided with a 50:50 split on the Fed signaling two more cuts by year-end – with our view leaning to one more.
Policy paths split
The easing cycle may not be the one-way street markets are hoping for. While the Fed steps toward cuts, the policy map elsewhere looks more fractured. The Bank of England’s hawkish 25bps cut in August underscored how entrenched inflation concerns remain, with food and energy spillovers and a likely 4% inflation peak in September keeping policymakers reluctant to ease. But add in growth risks from likely fiscal tightening this November and the Bank of England may find itself behind the curve, making gilts attractive particularly in the belly of the curve.
Across the Atlantic, the Bank of Canada faces its own bind. Growth is fading, but sticky inflation has kept the BoC cautious, leaving markets braced for a close call on another rate cut. A similar tone prevails in Norway, where a tight labour market and currency weakness have left Norges Bank watchers wary of a looser policy stance this week, parting ways with the global shift toward easing.
The ECB, meanwhile, signaled comfort with its current policy stance, with an insurance cut only needed if data deteriorates. And then there is Japan: an outlier entirely. With price pressures broadening, there is scope for a 25bp hike by year-end, making the BoJ the lone DM central bank leaning into tightening. Markets will be watching for hints that the October meeting could be live, a move yet to be priced – underpinning our bearish USDJPY view of 140 by year-end.
So… what does it mean for investors?
The result is a patchwork of central bank stances: a Fed cutting cautiously, a BoE and BoC facing close calls on further rate reductions, an ECB seeing policy in a good place, and a BoJ preparing to move in the opposite direction. For investors, this divergence may matter more than the Fed’s initial move.
FX markets are already adjusting. Easing hedging costs – as the Fed cuts while others stays put – will make US assets cheaper to hold on a hedged basis. Foreigners have started paring back USD exposure in favour of hedged positions in both equities and bonds, a shift that could accelerate if policy paths continue to widen. All in, increasing the appeal of US assets to foreign investors, or US exceptionalism with a twist – a weaker greenback.
Bottom line:
The Fed will cut — but the narrative matters more than the move. With six cuts priced, disappointment risk looms large. Diverging global policy paths – from the BoE’s fiscal caution to the ECB’s pause and Japan’s tightening bias – argue for selectivity. Our stance: selectivity in US risk assets with short-duration fixed income appealing, constructive gilts, bullish yen, and staying alert to the shifting FX hedging tide.
By Laura Cooper, Senior Macro Strategist at Nuveen
