The pound has hit its highest level against the US dollar since March 2022 after the chair of the Federal Reserve declared that “the time has come” for an interest rate cut.
Jay Powell’s remarks to the US central bank’s annual economic conference at Jackson Hole, Wyoming, did not specify when rate cuts would begin or how large they might be.
But financial markets and economists widely expect a quarter-point reduction in the Fed’s benchmark rate – the first since its hiking cycle began in 2022 – when its rate-setting committee next meets in mid-September.
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“The time has come for policy to adjust,” Mr Powell said.
“The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Should predictions prove accurate, the Fed will follow the European Central Bank and Bank of England in starting to adjust policy after sharp rises in interest rates to combat inflation.
The seeds of price growth were sown when economies began to gradually reopen following the COVID pandemic but the pace rose substantially in the wake of Russia’s invasion of Ukraine, taking inflation to a 40-year high.
Inflation across Western economies has proved more stubborn to shake than many expected – with central banks anxious to avoid so-called secondary effects such as prices being stoked further by high wage increases.
Mr Powell said that the US jobs market was “no longer overheated”.
Fed chair Jay Powell. File pic: Reuters
The purpose of interest rate increases is to choke demand – helping price growth ease as a consequence.
Higher interest rates are generally supportive of a domestic currency.
A lack of guidance on how many cuts were likely across the rest of the year bolstered market predictions that several were on the cards before the end of 2024.
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Bailey rules out rapid rate cuts
That pushed the US currency sharply down against a basket of international rivals.
The pound stood above $1.32 – more than a cent up on the day. It had stood at $1.30 earlier this week.
The gains are good for UK holidaymakers heading across the Atlantic as their pounds will go further if reflected in rates at the currency exchange.
Even the cost of servicing UK government debt dropped, with the yield on 10 year bonds down five basis points to 3.9%.
Stock markets put on some gains across Europe and in the US.
The FTSE 100 was 0.5% higher – building on earlier gains that were put down to expectations of Mr Powell’s remarks.
In New York the S&P 500 was more than 1% higher.
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The gains prompted warnings of caution in some quarters.
George Lagarias, chief economist at Forvis Mazars, said: “The immediate market reaction seems again to be one of unjustified exuberance.
“Despite the Fed’s lack of clarity regarding the pace of rate cuts, bond markets continue to price in four cuts this year.
“We believe investors should pace themselves in the next few months… for the Fed certainly will.”
Is there method to the madness? Donald Trump and his acolytes would have you believe so.
The US president is standing firm among all the market chaos.
Just this weekend, after US stock markets suffered their sharpest falls since the onset of the pandemic, Trump reposted a video on his social media platform Truth Social. This was its title: “Trump is purposefully CRASHING the market.”
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The video claimed the president was engineering a flight to US government bonds, also known as treasuries – a safe haven in turbulent times. The video suggested Trump was deliberately throwing the stock market into chaos so investors would take their money out and buy bonds instead.
Why? Because demand for treasuries pushes up the price of the bonds, and that, in turn, lowers the yield on those bonds.
The yield is the interest rate on the debt, so a lower yield pushes down government borrowing costs. That would provide some relief for a government that has $9.2trn of government debt to refinance this year. Consumers also stand to benefit as the US Federal Reserve, the US central bank, would likely follow suit, feeling the pressure to cut interest rates.
A trader works on the floor at the New York Stock Exchange. Pic: Reuters
Trump and his treasury secretary, Scott Bessent, have made it a key policy priority to lower yields. For a while, it looked like the plan was working. As stock markets tumbled in response to Trump’s tariffs agenda, investors ploughed their money into bonds instead.
However, Trump may have spoken too soon. On Monday, the markets had a change of heart and rapidly started selling government bonds. Thirty-year treasury yields hit 4.92% on Wednesday, their biggest three-day jump since 1982. That means government borrowing costs are rising – and not just in the US. The sell-off has spiralled to government bonds worldwide.
Rachel Reeves will be watching anxiously. Yields on Britain’s 30-year government bonds, also known as gilts, hit their highest level since May 1998. They registered a 27 basis point jump to 5.642% today – that’s on track to be the largest one-day move since the aftermath of former prime minister Liz Truss’ “mini-budget” in October 2022.
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This is a big deal. It is the sharpest sell-off in the US bond market since the pandemic. Back then, investors also rushed into bonds before dumping them and the motivations, on one level, are similar.
In 2020, investors sold bonds because they had to cover losses elsewhere in their portfolios. When markets fall, as they have done over the past few days, lenders can demand that an investor who has borrowed money stump up more cash against the value of their loan because the collateral against those loans has fallen in value. This is known as a “margin call”. Government bonds are easy to sell as investors “dash for cash”.
There are signs that this may be happening again and central banks, which had to step in last time, are alert.
The Bank of England warned today of the growing risks to financial stability. “A sharp increase in government bond yields could crystallise relatively quickly,” it said.
There are other forces weighing on government bonds. With policy uncertainty unfolding in the US, investors could also be signalling that US debt isn’t the safe haven it once was. That loss of confidence also seems to have hurt the dollar, one of the world’s safest places to park your money. It’s had a turbulent journey but is down 1.15% against a basket of safe haven currencies since Trump announced widespread tariffs on 2 April.
Some are even wondering if China could be behind some of this, dumping US government debt as a revenge tactic to hurt a president who has explicitly said he wants bond yields to come down. The country holds $761bn of US government bonds, second only to Japan. If this is the case, then the US-China trade war could rapidly be evolving into a financial war.
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