Interest rate cuts dominated financial markets

Looking back at the third quarter, these are the main developments:

In September, the American central bank (Fed) lowered its policy interest rate by 50 basis points to a range of 4.75% to 5%. This was the first interest rate cut since March 2020. Financial markets had expected a cut of only 25 basis points. The Fed also indicated further rate cuts, as it wants to avoid a further easing of the American labour market.

The European central bank (ECB) also lowered interest rates in September, by 25 basis points to 3.5%. The ECB hinted at further rate cuts for this year.

For bonds, it was a good quarter because of the expectation of a more rapid cycle of easing by central banks over the months ahead. When interest rates decline, bond prices rise. 

In early August, financial markets were briefly in turmoil. Macro-economic data published in the United States (USA) was weak, triggering fear for a recession in the USA. In addition, there was anxiety about possible further interest rate hikes in Japan. This followed after the Bank of Japan increased its key interest rate from 0.10% to 0.25% and indicated that 0.50% would not necessarily be the ceiling. As a result of these developments in Japan and potential interest rate cuts in the USA, the Japanese Yen gained strength, pushing up the prices of borrowing in the Japanese currency and, consequently “carry trading” as well. In a “carry trade” money is borrowed at a relatively low interest rate, in this case the Japanese Yen, in order to be invested elsewhere. The rising interest rate in Japan led to the reversal of “carry trades”.

The turmoil faded away quickly when macro-economic data from the USA turned positive. Moreover, a Japanese central banker announced that possible rate increases will not be implemented if the financial markets were not stable. The American and the European central bank also lowered interest rates. As a result, financial markets cooled down.

At the end of September, the Chinese government introduced a major package of measures to boost economic growth. The Chinese central bank lowered interest rates, mortgage rates and the reserve ratio for banks. In addition, banks were given a capital injection and two facilities (a swap facility and specialized re-lending facility)  were set up to boost the equity markets.