Fed Kicks Off Rate-Cutting Cycle. Why the Muted Market Reaction?

9月19日

Central bank bros met traders’ loftiest expectations with a half-point cut to interest rates on Wednesday. But is that too good to be true and maybe even a signal of some problems with the US economy and looming fears over at the Fed?

Trading today isn’t the same as trading yesterday. Even though prices don’t really confirm it — there wasn’t a super-duper rally in stocks. Maybe gold XAUUSD flickered a bit, but it was mostly froth. And here we are — the first day of trading in an environment with lower interest rates.

Jay Powell, head of the Federal Reserve, announced on Wednesday the first trim to borrowing costs in four years. The move ushers in a new normal where US interest rates USINTR are projected to continue moving lower from their 23-year high of 5.5%.

The easing cycle kicked off with a jumbo-sized 50 bps (basis points) slash. Surprisingly, the Fed went for the juicier, bolder and more aggressive option, leapfrogging the less interesting and exciting cut of 25 bps.

First reactions across the board showed investors were hyped to get what they wanted — the broad-based S&P 500 hit an intraday record.

Shortly after, however, stocks across the board pulled back and markets became anxious over the outlook as the realization kicked in. If the economy is doing fine, why go big on cuts from the get-go?

What’s more, central bankers are keen to ax interest rates by another half point in 2024, ultimately wrapping up the year with the benchmark rate sitting at 4.25% to 4.5%. Christmas may come early — the Fed meets twice more this year, on November 7 and December 18.

Better Safe Than Sorry?

A super-sized half-point cut could actually be a pre-emptive measure to alleviate a strained economy. But if inflation is now largely in the rearview mirror, what could the problem be? The other mandate. The Fed has a dual mandate of keeping prices in check (inflation) and upholding a stable labor market (jobs).

“We will do everything we can to support a strong labor market as we make further progress towards price stability,” Jay Powell said at the annual Jackson Hole gathering last month. And indeed, America’s jobs have seen a pronounced slowdown over the past few months. In July, markets added just 89,000 jobs (revised from an initial estimation of 114,000). In August, hiring had picked up modestly to 142,000, but below expectations for 164,000.

Pros and Cons of Bumper Cut

Essentially, this big-boy cut of 50 bps is a double-edged sword. It cuts into borrowing costs, making money more affordable, potentially stimulating businesses to add more jobs and grow their gig. And it also prompts consumers to take on debt and get that house.

But on the flip side, a cut of that magnitude risks stirring up price pressures again. To get to full employment, the Fed faces the challenge of knocked inflation waking up from its slumber.

The size of the cut at this particular time doesn’t mean anything without the markets’ reaction to it. Apparently, investors were unimpressed and shrugged it off as no big deal. Looking ahead, however, the stakes are high because stocks are at all-time highs.

The S&P 500 touched a record, Big Tech is leading the charge into artificial intelligence and investors can’t own enough of the highflyers Nvidia NVDA, Meta META, Apple AAPL, etc.

The actual picture will become clear once markets figure out what the Fed’s rate-cutting cycle means and what to do about it.