Falling Borrowing Costs Should Act Like Jet Fuel For Stocks
The global interest rate outlook is quickly dropping…
There’s an old saying on Wall Street that I learned very early in my career… Don’t fight the Fed! It’s a quip from former finance professor and famed investor Marty Zweig. He was referring to the correlation between the stock market and central bank policy.
You see, when the Federal Reserve, or other central banks, are lowering interest rates, the cost to borrow money drops. At the same time, the value of the underlying currency (in our case the U.S. dollar) declines because its effectively yielding less. So, fund managers or financial institutions, who had been hoarding the currency due to its rising worth, start to dump it. They either lend it out to others or find a higher-yielding asset to invest in.
The change means businesses and households have an easier time getting their hands on money. But it also means that investors who employ leverage, like hedge funds, don’t have to pay as much to use it. So, they’re willing to tolerate more risk when they invest. Typically, that means they’re less inclined to buy low-yielding safety assets like bonds or money market funds and more inclined to chase high returns in more volatile investments like stocks and bitcoin.
Over the last couple of days, several major central banks lowered interest rates. Each institution also signaled its willingness to reduce borrowing costs even more next year. Like I said previously, that means it should be easier for investors to gain access to more funds to invest. That should continue to underpin a steady rally in the S&P 500 Index.
But don’t take my word for it, let’s look at what the data’s telling us…
Yesterday, the European Central Bank cut its deposit facility rate by 25 basis points to 3%. However, President Christine Lagarde signaled it's prepared to reduce borrowing costs much more.
While speaking to reporters, she noted the inflation slowdown is accelerating. She said price pressures could fall below the central bank’s 2% target sooner than previously expected in 2025. Yet she noted interest rates still remain in restrictive territory, meaning they're still weighing on prices.
She elaborated that policymakers are worried about the economic growth outlook. She said businesses are pulling back on spending because they're worried about demand. The group feels output risks are still to the downside. Policymakers are concerned trade tensions have the potential to make the matter worse.
As a result, the Governing Council did not discuss the neutral rate of interest (neither hurts nor helps the economy) over the last couple of days. It debated the potential for cutting rates by as much as 50 basis points. But instead, it chose the more conservative choice to leave itself room for future accommodation.
Lagarde said The ECB is still focused on doing everything it can to support the economy. That's central bank speak for lowering borrowing costs to boost lending and spending. And when asked whether a rate cut was possible at the January meeting, the ECB chief left the door open, saying she wouldn’t comment right now.
This was a strikingly more dovish (inclined to lower rates) outlook from Lagarde. Previously, she expressed concern about a rebound in growth, inflation, and employment. Those scenarios were not part of yesterday’s discussion. Even more important, the statement came on the heels of two other notable monetary policy decisions from the Bank of Canada ("BOC") and the Swiss National Bank ("SNB").
On Wednesday, BOC Governor Tiff Macklem announced it was lowering interest rates by 50 basis points, for the second consecutive meeting, to 3.25%. It is still worried about a softening growth outlook and remains prepared to support output...
Yesterday, the Swiss National Bank also took a similar step. It cut the policy rate by 50 basis points to 0.5%. This was the largest rate cut since January 2015. It said inflation continues to weaken and policymakers are increasingly concerned about the global economy. They are prepared to ease further in an effort to support domestic growth and price stability...
All of this is important as it affects the U.S. dollar and Federal Reserve policy decisions. The euro makes up 57.6% of the dollar basket while the Canadian dollar is 9.1%, and the Swiss franc is 3.6%. In other words, 70% of the currencies that drive the dollar's buying power up and down, are weakening...
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So, this week’s central bank decisions, in addition to the future policy guidance, tell us that other major central banks are going to cut interest rates even more next year. The heads of those institutions are no longer sounding worried about rising prices but instead concerned with falling employment and declining economic growth. So, they’re going to pull out the crisis playbook they know best and keep lowering rates until spending picks up.
The shift is a big deal for the Fed. Because as those other central banks keep reducing borrowing costs, it will weigh on the value of their currencies. That should give Chairman Jerome Powell more room to cut rates without stoking inflation. And as it starts to cost less for investors everywhere to borrow, some will start to lever up. They’ll inevitably seek out higher returns in risk assets, underpinning a steady rally in the S&P 500.
Five Stories Moving the Market:
China signaled more public borrowing and spending in 2025 with a shift of policy focus to consumption, in an effort to repair the economy’s weak link as looming U.S. tariffs threaten exports – Bloomberg. (Why you should care - for only the second time in at least a decade, Beijing made “lifting consumption vigorously” and stimulating overall domestic demand their top priority
The Trump transition team has started to explore pathways to dramatically shrink, consolidate or even eliminate the top bank watchdogs in Washington; in recent interviews with potential nominees to lead bank regulatory agencies, Trump advisers and officials from his newfound Department of Government Efficiency have, for example, asked whether the president-elect could abolish the Federal Deposit Insurance Corp. – WSJ. (Why you should care – less regulation would boost the margin outlook for financial institutions)
The European Central Bank cut interest rates by a quarter-point to 3%, as it watered down its hawkish language and warned that growth would be weaker than it had previously forecast – FT. (Why you should care – the ECB set the table for additional rate cuts next year)
The Swiss National Bank cut its interest rate by 50 basis points, its biggest reduction in almost 10 years, responding to weaker than expected inflation in Switzerland and growing uncertainty about the global economy – Reuters. (Why you should care – the SNB expects inflation and growth to keep sliding, likely meaning more economic support)
U.S. producer prices increased by the most in five months in November, but services costs such as portfolio management fees and airline fares eased, offering hope that the disinflationary trend remains in place despite stalled progress – Reuters. (Why you should care – easing services costs implies personal consumption expenditures growth should be soft)
Economic Calendar:
China – New Yuan Loans for November
U.K. – GDP for October (2 a.m.)
Germany – Exports, Imports for October (2 a.m.)
Eurozone – Industrial Production for October (5 a.m.)
U.S. – Export Price Index for November (8:30 a.m.)
U.S. - Baker Hughes Rig Count (1 p.m.)
U.S. - CFTC’s Commitment of Traders Report (3:30 p.m.)
Fed Releases Balance Sheet Updates on Commercial Banks (4:15 p.m.)