The Fed is returning to monetary easing. Will it be different this time?

The beginnings of the easing cycles by Fed often involve risk, but the current political climate is unlike any other in modern history. Public confidence is low, while financial markets continue to surge.

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of faith, it was the epoch of disbelief, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.”" – Charles Dickens, "A Tale of Two Cities."

Fed introduces new easing in times of contradiction

Charles Dickens's "A Tale of Two Cities" is a story set against the backdrop of the French Revolution, depicting the contrast between London and Paris and the paradoxical juxtaposition of intellectual ferment and the great wealth of the few and the immense poverty of the many. Similarly, the prosperous British Empire at its peak was rife with contrasts between wealth and progress and the immense poverty of the cities. If we look at today's times and the ever-crucial US economy, one might think we're living in the worst possible times, given the near-record low in consumer sentiment according to a University of Michigan study and the worst approval ratings in the history of any president in his first year in office. Donald Trump.

The stock market—for investors, and (at least for the giants and AI-related companies)—is booming, as the overall stock market reached record highs in Q3, and more importantly, record valuations. These record-breaking figures apply to both earnings and, perhaps more surprisingly, sales. Indeed, S&P 500 companies achieved a staggering valuation in Q3—over 3,3 times sales. At the market's peak in 2007, this price-to-sales ratio was just over 1,5.

At the global level, Chinese markets are booming as China fosters a domestic technological revolution, seeking independence from, and even competition from, the West.

During this time, European large companies have significantly outperformed the US market in dollar terms, and emerging markets have also outperformed the US, at least in dollar terms. These differences are stark, and the future is more uncertain than ever. Will global markets continue to rally, benefiting from the additional stimulus provided by the Fed's new monetary easing policy announced at its September meeting? FOMC, and a weaker US dollar? Or are we facing a slowdown in growth as the effects of tariffs accumulate, the high interest rates from the previous cycle begin to be felt, or as the pace of AI spending slows?

Is the risk of recession in the US increasing, or is it just the effect of tariffs?

We still see a growing risk of a US recession, but if it doesn't materialize in Q4, it could be the result of a short-term surge in demand related to decreasing trade policy uncertainty. Furthermore, companies are encouraged to invest thanks to the "Big Beautiful Act," which allows for full 100% depreciation in the year of real estate and equipment purchases. Some companies may now be more aggressive in diversifying their supply chains. On the other hand, as we discuss below in the context of the stock market, AI investments could prove significantly more important than other capital spending changes and represent a key driver of US economic growth this year.

Furthermore, the impact of the Trump administration's anti-immigration policies and their impact on the economy is a difficult factor to measure in the medium term, especially due to weak official data and unclear information about informal employment. We do not include the Fed's monetary easing policy in our growth forecasts, which may be somewhat unfair, as wealth effects are becoming increasingly important in the financialized US economy. However, for the rest of the economy, the Fed's policies will have a significant lag, likely not until next year.

In recent years the exchange rate EURUSD It largely tracked the difference in yields on the two blocs' long-term debt, as seen in this chart by the spread between the yields on 10-year U.S. Treasury bonds and German Bunds. This year saw a particularly divergence, initially when Germany announced a massive fiscal expansion, which caused German and European bond yields to spike relative to their global peers. Fiscal expansion typically favors a currency. The subsequent rise in the euro against the U.S. dollar is harder to attribute to anything happening in Europe and more likely stems from concerns that Trump's trade barriers and U.S. Treasury policies will mean that capital returning to the U.S. market isn't associated with strong returns.

Iran-Israel conflict: will the situation calm down or escalate?

The forecast comes as fighting between Israel and Iran has resumed, as Israel seeks to block Iran's nuclear ambitions. The impact on oil markets has been dramatic, raising fears of a new wave of inflation. However, the effects of geopolitical tensions are very difficult to predict. Central banks, which influence monetary policy, may ignore rising energy prices if overall economic sentiment and growth prospects deteriorate. In such a case, they may maintain accommodative monetary policy even if rising energy prices trigger inflation.

Risk of recession in the US

Recession risks are likely to increase in the second half of the year, partly due to a slowdown following strong growth earlier in the year and indications of weakness in key economic indicators. High Fed interest rates, relative to inflation, are increasing pressure on the economy, and the housing market is starting to show signs of serious problems. Our main scenario is a mild recession in the second half of the year, before inflation accelerates early next year, ahead of the midterm elections in the US.

A further downside risk to growth forecasts this year stems from tariffs, which act like taxes. Increasing the price of a good doesn't mean there's suddenly more money available to buy it. In practice, people either buy less of that good or less of other things, leading to a real decline in economic growth. Trump's anti-immigration policies could also have a surprisingly large impact, as ICE crackdowns and pressure on people without legal status could force some into the underground economy, and some might even voluntarily leave the country. Although hard data are lacking, this can be expected to impact consumption and labor supply in industries that employ the most people without legal status, such as agriculture, construction, and the hospitality industry.

An uncertain factor for the US and global economy is whether AI-driven disruption could trigger the first true recession in the higher-skilled sector, where jobs are replaced by efficient AI tools. Concrete data on AI's impact may emerge soon.

Expected market results:

The USD will remain weak. Precious metals will remain strong.

Trump 2.0's policies are anti-globalization, what economist Russell Napier calls "national capitalism" and others have called "reverse mercantilism," as the US attempts to unravel the global order it built after World War II. It fostered the growth of the global economy and ensured low prices for American consumers. A strong dollar was the foundation of this global order, as mercantilist countries deliberately weakened their currencies to build export-driven economies. This, in turn, led to a decline in US manufacturing and made the country more vulnerable to supply chain disruptions, which has become a national security issue. Despite Trump's transactional style and the imposition of trade barriers, the US dollar will continue to be the most important currency, though its importance will be less than in the past.

Other major economic players will invest less in the US economy, US stocks, and US Treasury bonds, and will instead have to focus on balancing their savings and consumption domestically. Europe is already showing clear signs of this, stemming from the sudden uncertainty surrounding the US's commitment to the transatlantic alliance and Trump's stance on trade terms. Germany's strong fiscal expansion has significantly strengthened the euro, and the EUR/USD exchange rate could reach 1,25 by the end of the year. Japan is delaying negotiations with the Trump administration, which may be a result of the domestic political situation in Japan. However, the very weak Japanese currency is a warning sign for US-Japan trade relations, which will likely require a correction, leading to a significant strengthening of the yen.

Precious metals are driving the raw materials sector to strong results in the first half of the year. More gains lie ahead.

The commodities sector has performed very well in the first half of the year, with the Bloomberg Commodities Index up around 9% at the time of writing, significantly outperforming other US dollar-denominated assets such as bonds and stocks. S & P 500 i Nasdaq lagging far behind. While commodity prices typically rise when economies are booming, the current growth is primarily driven by geopolitical risks and rising investment demand for tangible assets, particularly precious metals.

Gold prices are at their highest levels in months, with silver and platinum joining the rally, fueled by growing concerns about rising national debt, supply chain problems caused by tariffs, a slowing labor market, and continued weakness in the U.S. dollar. These factors could eventually prompt the Federal Reserve to shift its policy to a more easing, and potentially stronger, stance than expected. Additionally, the risk of higher inflation and continued gold purchases by central banks could lead to further price increases, with gold potentially reaching $4,000 within the next year.

Silver's strong September rally lifted the price of the metal to a 14-year high, surpassing $47. After a period of underperformance relative to gold—due to rising central bank demand for gold—the recent rally has brought the gold-silver ratio back to its 10-year average of around 81. Silver will likely need support from gold to reach its 2011 record high of $50. If gold reaches $4,000, silver could gain enough strength to achieve this goal in the coming months.

About the Author

Ole Hansen, head of department of commodity market strategy, Saxo Bank. Djoined a group Saxo Bank in 2008. Focuses on providing strategies and analyzes of global commodity markets identified by foundations, market sentiment and technical development. Hansen is the author of the weekly update of the situation on the goods market and also provides customers with opinions on trading goods under the #SaxoStrats brand. He regularly cooperates with both television and printed media, including CNBC, Bloomberg, Reuters, Wall Street Journal, Financial Times and Telegraph.