In their September 18th meeting the board of the Fed announced that they will be starting their rate cut operation with a larger 50 basis-point cut, bringing Fed rates down to a range of 4.75% to 5%. This decision came as a wonderful surprise to investors as many believed that a minor 25 basis-point cut would be the first step for the Fed. On the day of the announcement, the markets didn’t have much of a reaction. The S&P quickly rose about 1% when the announcement was made but then quickly faded back near its prior trading area.
However, the day after the announcement was made (the 19th) prices soared across all markets and several major indices broke out to new all-time highs. Ines Ferre of Yahoo wrote, “The Dow Jones Industrial Average rose to close above the 42,000 level for the first time ever while the S&P 500 also soared 1.7% to new highs, closing just over 5,700 a day after the Federal Reserve announced a jumbo rate cut.”
One reason that the market didn’t take the news well on day one but started to move day two is that many traders anticipated the 50 basis-point cut and made a “buy the rumor, sell the news” trade. The main idea of a trade like this is to buy the anticipation surge in the weeks prior to the announcement, and then once markets have already priced in the announcement, traders short the initial pop in price on day one to take advantage of the short-term euphoria that investors who are late to the game will be deceived by. The market spent the day of the announcement digesting this sort of price action so on day two it was ready to surge higher.
So it looks as though the market is extremely optimistic about the rate cut that's been made and the roadmap that the Fed has outlined for the future, but we are still seeing the market digest this in real time. So, what do investor’s need to be looking at/for in the coming months?
The Future after the Rate Cut
Some investors see the current situation we’re in as an opportunity for investors to favorably position themselves for the future. Erik Aarts, a fixed income strategist at Touchstone Investments said the following in an interview with MarketWatch, “Our call, as a committee, is that we are going to see a soft landing. The old adage about buying the rumor and selling the news, I think we are going to see a little of that. If you haven’t locked in yields, you get a chance to do that here,” Aarts said. “Interest rates and bonds still are at levels that are attractive to investors who may have been waiting for this first rate cut to act.”
It will be important for investors to watch macroeconomic data, specifically labor market data, over the next few months and weeks as these data will be the key determining factor in how the Fed will act going forward. Joy Wiltermuth of MarketWatch writes, “Clearly, the trajectory of the labor market will loom large in terms of informing the Fed’s next steps on interest rates. Fresh data Thursday showed the number of Americans who applied for unemployment benefits dropped to the lowest level since May. Stock performance in the wake of previous Fed rate-cutting cycles has been mixed, with the economy being the deciding factor in whether investors see sharp losses or gains in equities.” Economic data releases in the coming months will be the best indicator for how the Fed will continue in their rate cut campaign.
Did the Rate Cut Save Us From Recession? Or Did It Just Delay It?
Although markets reacted extremely positively to the Fed’s decision to go for a more aggressive 50 basis point cut, only time will tell how things will play out. Some economists are still unconvinced that the Fed is on track to save us from a recession. One of these economists, President of Rosenberg Research David Rosenberg, spoke with MarketWatch and provided his thoughts and outlook on the current economic situation. To start, Rosenberg believes that the Fed’s decision on Wednesday was done too late. “The Fed moving 50 basis points was nothing more than an acknowledgement that it had stayed too tight for too long,” Jonathan Burton of MarketWatch summarized Rosenberg’s thoughts in the following, “Rosenberg says he doesn’t believe the Fed will move aggressively or urgently enough to keep the U.S. economy out of recession. He reasons that since the Fed was slow to fight inflation, it will be behind the curve to combat an economic slowdown. So Rosenberg is steering investors towards rate-sensitive assets that, while not necessarily recession-proof, are better-positioned to benefit from a Fed monetary easing cycle that he expects will take the federal funds rate down to a pre-Covid level of 1.75%.” In addition, Rosenberg said “There’s two things to consider. This rate cut was already on the table at the last Fed meeting in late July. But they decided not to pull the trigger. So ordinarily they would have cut by 25 basis points then and 25 basis points now. The 50 basis-point cut basically acknowledges that they missed the opportunity to engage in the first rate cut six weeks ago; so they doubled down.”
Rosenberg then goes on to share his thoughts on how investors should be allocating capital in a situation like this. “In the stock market you want to be in sectors that perform well in a period of slower growth, lower inflation and lower interest rates. This would include utilities, telecom services, real estate, financials and dividend-paying growth stocks with high payout ratios. As for tech stocks and other investor favorites, ordinarily a lower discount rate would be good news. But multiples are still too stupidly high for me to be recommending them.”
So, Rosenberg believes that the Fed will remain on a campaign of rate cuts on its way back down to a Fed funds rate near pre-Covid levels. However, he believes that because the Fed was late to the game a recession is still imminent. Thus, you should be putting your capital into investments and sectors that perform well in slow growth environments. Only time will tell if Rosenberg’s analysis is correct and we really are heading that way. Either way, investors should be doing their due diligence and tilting their portfolios accordingly.
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