Investors should focus on the key reasons behind the US Federal Reserve’s decision to cut interest rates, as the depth and speed of the cuts are crucial in shaping the outlook for both bonds and equities, according to Gargi Pal Chaudhuri, managing director, chief investment and portfolio strategist, Americas at BlackRock.
"Are they cutting rates because inflation is coming down in a meaningful manner, or are they cutting rates to stave off a recession?" she asked.
While rate cuts often signal a response to recession fears, current data does not indicate an imminent downturn, even as labour market trends soften. The strategist spoke on how these cuts could shape market behaviour, as it has already priced in a reduction to 2.75%.
History Suggests Rate Cuts Follow Recessions
But that might not be the case this time.
Although, past rate cuts have frequently been followed by recessions, such as the 1995 and 2019 cuts and the 2020 rate-cutting cycle which was initiated during an ongoing recession, this time around, things might be different, Chaudhuri notes.
"We've seen the labour market in the US softening a little bit from about six months ago, but none of the data recessionary territory yet," she said.
The manufacturing sector, consumer spending, labour market—none of them are pointing to a recession, she said. But warned that it can of course change, "and a lot of that will depend on how the Fed handles this cut cycle".
Equity markets tend to perform well 12 months into a rate-cutting cycle, Chaudhuri said.
"We’re telling investors to stay up in quality during this period of slowing growth." There are significant opportunities in fixed income due to the attractive yields currently available, she said.
Emerging Markets Provide Prime Opportunities
Emerging markets—particularly India and Mexico—should be key considerations for younger investors looking to diversify, according to Chaudhuri.
"Emerging markets fit the bill very well, especially for those at the beginning of their careers," she said, citing the accommodative nature of central banks in these regions and favourable demographic.
With growth potential in emerging markets remaining strong, she suggested that long-term investments in these economies could yield positive returns.
As investors plan their asset allocation, Chaudhuri said that the importance lies in factoring individual investment goals and risk tolerance, particularly when considering the potential for growth in emerging market equities.
Market Already Priced In Rate Cuts Upto 2.75%
Much of the expected Fed rate cuts have already been factored in by the markets and investors, Chaudhuri said.
"The market is pricing in that rates will come down to the 2.75% mark fairly quickly," she said, pointing out that by 2026, markets expect the Federal Reserve's interest rates to settle near this level.
This aligns with previous rate-cut cycles, such as the 2019 reduction when rates were in the mid-2% range. This was when the economy was doing well right before the Covid-induced cuts.
But the prospect of rates dropping significantly below 2% and the likelihood of rates returning to pre-pandemic levels is slim, she said.
Expect Market Volatility Ahead Of US Elections
Looking ahead, Chaudhuri warned that emerging markets could face heightened volatility due to the upcoming US elections.
"Investors should be a little bit cognizant that with the US elections nearing. It could be a period of volatility for emerging markets," she said.
While this period may present challenges, emerging market equities and debt will remain attractive investments post-election, Chaudhuri said. High-quality investments and companies with solid cash flows and earnings are likely to perform well during this period of uncertainty. This might also help cushion investors during the volatile election-period.
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