By Naomi Rovnick and Yoruk Bahceli
LONDON (Reuters) - Big global investors are on alert for wild market swings after a jumbo U.S. rate cut sparked confusion over whether the world's dominant economy is set to boom or face recession, muddling prospects for stocks, bonds and currencies worldwide.
Global stocks hit records on Thursday, a day after the Federal Reserve lowered borrowing costs by 50 basis points from a 23-year high while the euro, sterling and currencies from Norway to Australia firmed against the dollar. U.S. stocks surged after an initial muted reaction to the Fed cut.
But in one sign the Fed's cut is making policymakers outside the U.S. edgy, the Bank of England held interest rates steady on Thursday, citing uncertainty about inflation and global demand.
Traders dialed back their UK rate cut forecasts and some money managers warned the Fed might be adding too much support to an already robust U.S. economy, lifting global growth but potentially also prices of commodities and consumer goods.
"I think it's more likely the Fed cuts too much and the economy accelerates," Royal London head of multi-asset Trevor Greetham said.
"It might be that there are then not loads of (global) rate cuts," he said, adding he expected higher market volatility from here.
"I see more turbulence, there are just too many risks," Legal & General Investment Management head of economics Tim Drayson said, citing prospects that the U.S. was slowing.
LGIM, Britain's biggest asset manager, was not taking strong positions on global stocks and bonds for now, he said.
DIVERGENCE?
Traders see the Fed's funds rate dropping 72 bps this year and by 195 bps by October 2025.
They have reduced near-unanimous bets for a quarter-point UK rate cut in November to around 80% and see the European Central Bank as unlikely to cut rates next month, but investors viewed such predictions as unstable.
These European rate-setters are grappling with slower growth than the U.S, but stickier inflation. Their policy paths and markets depend on a scattergram of unpredictable scenarios for the U.S. economy.
Fidelity International portfolio manager Shamil Gohil said that faltering U.S. and UK growth could persuade the BoE to cut rates more rapidly and boost British government bonds, known as gilts.
But such positions were vulnerable to current expectations for further U.S. rate cuts proving wrong, he said.
"That could be a scenario where all markets sell off," he said, adding that on balance he expected global market volatility to rise.
Gohil said his portfolio was defensive, with a preference for investment-grade corporate bonds.
Neil Mehta, portfolio manager at BlueBay Asset Management, warned the Fed was cutting into a "very hot" economy with GDP growth at 3% and inflation still above target.
Euro-zone core inflation is just under 3% and its policymakers are divided over future rate cuts after it lowered borrowing costs in June and September.
But if the Fed keeps going, further strength in the euro against the dollar would pile pressure on the ECB by making exports less competitive, Greetham said.
Marcus Jennings, fixed-income strategist at Schroders (LON:SDR), said a dovish Fed, along with a weak euro-zone economy, made
German Bunds more attractive.
But investors warned any global central bank outlook was likely to shift if U.S. data changed views on what the Fed may do next.
"If you start to see (U.S.) employment contract they (Fed) would be much more aggressive," said TS Lombard head of macro Dario Perkins. "Then they would start to panic a little bit about what’s happening. If employment started to rebound, then that would suggest policy isn’t as massively tight as they thought".
The VIX gauge of implied stock-market volatility dipped to 16.6 on Thursday, far below its spike to almost 66 during early August's market turmoil on a surprisingly weak U.S. jobs report and follow-on currency market gyrations.
MSCI's world share index has also gained more than 10% since that Aug. 5 shakeout.
Marlborough chief investment officer Sheldon MacDonald said market volatility could rise because stock-market valuations suggested the U.S. economy would be boosted by rate cuts but government bond pricing hinted at a recession.
Ben Gutteridge, multi-asset manager at Invesco, said if the Fed prevents a recession this would boost trades centered on central-bank divergence, such as bets that a more restrictive BoE would keep the pound strengthening against the dollar.
But a U.S. downturn would weaken stocks and support bonds worldwide, narrowing regional market divergence, he said.
"If you don't want to lose money, you've got to get the Fed right."