Weekly wrap: The Fed's free pass to cut rates bolsters markets

Asian markets are on a bit of a winning streak, closing in on a fourth consecutive month of gains, fueled by the ever-tempting hope of a soft landing in the US economy and the sweet prospect of lower interest rates. Meanwhile, the 10-year bond yield in Japan is inching up, thanks to Tokyo’s August data showing a little heat in price pressures. It’s almost like the Bank of Japan is warming up for another round of policy tightening. After a couple of wobbly days, the yen is getting its act together, while Treasuries seem poised for a fourth straight monthly victory lap.

Still high on the Fed rate cut buzz, global markets celebrate the central bank’s apparent success in taming inflation without tipping the economy over. The US economy got a little extra boost in the second quarter from stronger-than-expected consumer spending, which is keeping recession fears at bay for now. Solid GDP numbers and stable job data have everyone feeling pretty good, but let’s not forget—the real test comes next week with the US employment report. Nonfarm payrolls on September 6th could be the plot twist no one saw coming.

The latest inflation data has all but handed the Fed a free pass to cut rates in September. The only real question left on the table is: How deep will they go?

The Fed’s rate path has been about as predictable as a game of pin the tail on the donkey this past year. We started 2024 with high hopes for seven 25 basis point cuts, only to watch those dreams evaporate by April. Now, we’re staring down the barrel of close to four cuts for the rest of the year, with another five teed up for 2025. Recent data has the market leaning towards a 25 basis point cut, but let’s not count out a surprise move just yet.

Here’s where it gets interesting—a 50 basis point cut might not be the market's best friend if it comes with hints of labour market weakness. In that case, the cuts might feel more like a desperate Hail Mary than a gentle nudge towards stability. A steady drip of 25 basis point cuts might be the sweet spot, keeping equity multiples content as long as growth stays on track.

But here’s the kicker—at 21x earnings, with the market already betting on 10% earnings growth this year and 15% next, a soft landing is practically baked into the cake. Longer-term rates have been edging lower since April in anticipation of this cutting cycle, but economic surprises have been a bit of a letdown, and interest rate-sensitive cyclical stocks have been dragging their feet. So, the real question is: Will these rate cuts be the magic bullet the market’s hoping for, or are we all just along for the ride?