There's bad news for global investors hooked on easy money and ultra-low interest rates!
The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is tipped to fall this morning in sympathy with US stock indices after the US Federal Reserve poured cold water on the prospects of further rate cuts.
The Fed's rate outlook came on the back of its 25 basis point cut to the official interest rate – it's first cut since 2008.
The cut was expected but the market was banking on two or three more reductions to the Fed Fund Rate before Fed chair Jerome Powell hinted that last night's cut could be a one-off.
He said that the decision to lower the rate was an insurance policy against signs of a slowing global growth but future cuts are dependent on bigger cracks emerging in the economy.
That sounds to me like a prudent and logical course of action but our market hasn't been driven much by logic over the past few months but by sentiment that's fuelled by central bank easing.
The question is whether this changes anything for ASX investors – and the answer is absolutely! There are three ways this will hit Aussie equity investors.
Painful market adjustment
The Fed's hardening stance means that the unquavering assumption by investors that we will see two to three more rate cuts in the US and Australia will be tested.
This isn't to say more cuts won't happen, but economic data will be needed to justify the move, while as before yesterday, investors had taken cuts to be a given and the markets have priced these in.
There is likely to be an unwinding of this assumption barring any bad economic news in the near-term, and that means the ASX 200 may have peaked.
Bad news becomes good
Another key takeaway following from the first point is that we are heading deeper into the bizarre world where bad news is good news. Shares may actually rally if we do see a deterioration in the global economy – such as a shaper than expected slowdown in the Chinese economy.
This phenomenon was already seeping into risk assets and Powell's comments will only reinforce the trend.
The Fed-RBA connection
The third thing investors should be thinking about is how the Fed will impact on the Reserve Bank of Australia's (RBA) thinking ahead of their rate decision next Tuesday.
I believe we will still see one rate cut before the end of this year but the RBA may not be as dovish in its statement compared to if the Fed had reinforced rate cut expectations in the US.
While the RBA makes its decision independently of other central banks, the fact is, monetary policy is impacted by relativity – particularly by the Fed due to it influence over US bond yields, which are the benchmark reference for other sovereigns.
Whether our central bankers admit it a not, if the Fed is backing away from more rate cuts, there will be less pressure on the RBA to lower the cash rate than there would be otherwise.
