Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

U.S. markets gyrated sharply on Wednesday after the Fed cut interest rates by 25 basis points, and investors digested its new economic projections and Chair Powell's press conference. The upshot? Bond yields and the dollar rose, while Wall Street was mixed.

More on that below. In my column today I look at how a resumption of the Fed's easing cycle means the U.S. central bank is now swimming against the global tide. This may have mixed blessing for world markets. 

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

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* Fed moves

The Fed delivered the quarter percentage point rate cut markets had expected, and it looks like there will be more to come. The emphasis on growing labor market risks and the new 'dot plot' point to at least another 50 bps of easing this year.

But it's far from clear-cut. Employment and inflation risks are incredibly hard to gauge, and Powell said the Fed is in a "meeting by meeting situation". You can't read too much into the market's initial reaction on Wednesday, but yields ended higher and nearly 10 bps of implied easing was taken out of the 2027 rates curve.

 * Rotation, rotation, rotation

The rotation out of Big Tech and growth stocks into small caps and cyclicals was a feature of the summer months but had cooled so far in September. It seemed to show its face on Wednesday, with the Dow and Russell 2000 closing higher and the Nasdaq falling 0.3%.

Where does it go from here, now that the Fed decision, revised SEP and Powell's guidance are out of the way? The Dow and Russell 2000 are still significantly lagging the Nasdaq and 'Mag 7' this year, and relative valuations suggest there is room to catch up. But AI optimism might suggest otherwise.

* Tariff squeeze

The impact from tariffs on the U.S. economy has clearly not been felt yet. Retail sales in August were much stronger than expected, the Atlanta Fed's GDPNow model currently has Q3 growth tracking at a healthy 3.4% annualized rate, and Citi's economic surprises index has been positive for over two months.

The question is - and has been for months - when does this change? "Pass-through to consumers delayed but not derailed," say BNP Paribas economists, who estimate U.S. firms have so far shouldered 64% of the tariff burden and consumers only 17%. They see that changing to 1% and 63%, respectively. Will that move the dial?

We're about to see a rare phenomenon in global central banking: the U.S. Federal Reserve is set to embark on an interest rate-cutting cycle just as many of its peers are winding theirs down. 

Strictly speaking, the Fed is resuming its easing cycle, having paused last December after announcing 100 basis points of cuts over the preceding three months. 

Regardless, the world's most important central bank is about to swim against the global tide, something investors haven't seen for many years, especially when it comes to policy easing. 

 The rest of the world, therefore, may need to be prepared for some choppy waters ahead.  

There have been four large global easing cycles since the euro's launch in 1999, including the current one. In the previous three, the Fed was either one of the first big central banks to move, as was the case in 2019, or among the most aggressive rate cutters, as was the case in the dotcom bust. 

But last year the Fed was relatively slow off the blocks, as sticky inflation and solid growth meant it pulled the trigger after most of its peers. 

As a result, the Fed now finds itself playing catch up to other monetary authorities, especially against the European Central Bank and Bank of Canada, which have cut rates 200 and 225 bps in this cycle, respectively. 

Rates futures markets are currently pricing in around 150 basis points of Fed rate cuts by the end of next year, far more than is expected in the rest of the developed world. Traders expect only another 40-60 bps over the same period from the BoE, BOC, and Reserve Banks of Australia and New Zealand. 

Meanwhile, the ECB and Swiss National Bank are thought to be done, while the Bank of Japan is slowly raising rates, taking its own unique path.

This policy divergence may create some problems beyond U.S. shores.