Mid-week market update: The Fed hates to surprise markets, but for the first time in a long time, market expectations of FOMC action was highly uncertain. Is the Fed going to cut by 25 or 50 bps? On the weekend, the majority expected a 25 bps cut, but by Monday, it had shifted to 50.
As it turns out, the decision was to cut by 50 bps. Expectations before and after the decision announcement were largely unchanged. It’s still expecting another 75 bps by year-end, which is more aggressive than the dot plot.
The Fed’s Summary of Economic Projections (SEP) showed two significant changes in projections since June. The unemployment rate is projected to rise to 4.4% from 4.0% by year-end, and the median dots is projecting another 50 bps cut by year-end.
Even then, the additional 50 bps cut was a close call. The dot plot shows that opinions were very split. Had opinions moved even slightly more hawkishly, the median year-end Fed Funds rate could have been 25 bps higher.
The history of market reactions
The equity market was muted in its response. The S&P 500 fell -0.3% in the face of the “good news”, but initial reactions to Fed decisions are often reversed the next day. The history of 50 bps cuts have tended to be bearish (blue lines), but those instances were reactions to recessions and panic about an economic slowdown.
Is this time different? During the press conference, Fed Chair Powell used the term “recalibrating” a lot, in that the Fed is undergoing a recalibration of its monetary policy after an intense focus on inflation to both sides of its dual mandate of inflation and full employment. The rate cuts aren’t a panicked response to recessionary conditions, but a recalibration of policy and risk management: “We don’t think we’re behind…. You can take this as a sign of our commitment not to get behind.”
Key risks
Here are the risks. Sentiment is already quite bullish. According to Goldman Sachs, positioning in equity futures is already at a crowded long.
According to the BoA Global Fund Manager Survey, the overwhelming consensus for the U.S. economy is a soft landing, which is a scenario that Powell sketched out at the press conference today.
In the meantime, the S&P 500 rallied after the FOMC decision but it failed to hold its gains and ended in the red on the day. More importantly, the intraday pullback was a key failure of a test of overhead resistance.
As well, the 50 bps cut will widen the spread between U.S. and Japanese yields and strengthen the Japanese Yen. Remember all the anxiety over the carry trade?
My inner trader remains short in the S&P 500. We will see in the coming days what the actual market response will be. The usual disclaimers apply to my trading positions.
I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.
Disclosure: Long SPXU
The yield curve is uninverted even more. Is it the election? Does super big money want the Dems to win? That makes no financial sense.
Copper is bouncing along with the S&P, but is acting weaker CPER:SPY also is not strong.
Are we in for a blow off top?
Why .50 and not .25? What is bothering them? Maybe DJT bothers JPOW.
Irrational is just that, we could see prices tank tomorrow, why, because things are irrational, or things could keep going higher for the same reason, irrational.