Mike Dolan’s outlook for the day ahead for US and global markets
Regarding the main events of the day, there was little to say later except the market’s reaction to the size of the Fed’s rate cut and future forecasts from Fed policymakers .
If anything, few doubt that the Fed is about to unleash its first easing of the cycle. Wall Street’s S&P 500 index (.SPX) hit a new intraday record ahead of Tuesday’s decision — expressing satisfaction at the prospect of lower borrowing costs even as the economy improves. Stock futures were steady overnight, heading into a big decision.
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The last minute check on the economy’s health assembled by Fed officials showed that retail sales unexpectedly rose again in August and factory output exceeded expectations, confounding the previous month’s more disappointing manufacturer surveys.
As a result, the Atlanta Fed’s “GDPNow” model subsequently raised its third quarter growth forecast by half a percentage point to 3%, a similar pace to second quarter economic growth.
Despite buoyant markets and a buoyant economy, futures still favor a 50 basis point rate cut by the Federal Reserve on Wednesday rather than the more traditional 25 basis point rate cut. Pricing is still at 40 basis points, with a 60% probability of bigger moves.
Former Fed economist Claudia Sahm on Tuesday became the latest Fed member to call for a sharp rate cut of 50 basis points this week, arguing that now is the time to take action to prevent unnecessary job losses and ensure the central bank achieves its dual goals.
“The Fed has been very supportive of the maximum employment goals in our dual mandate,” Sam said.
So, at first glance, with the big rate cuts, the economy is booming and inflation is back to normal. Those who study the market almanac carefully see only the positive side.
Of course, it could be different this time, but even with a recession, the average stock market return in the year following the Fed’s first rate cut is close to 5%. When there is no recession at all, that number will be over 16% — this is the most likely scenario investors are facing right now.
On the other hand, will the stock and bond markets be angry now if they do not get the support of a 50 basis point rate cut from the futures market?
To do this, we may need to look at how the rate cut lines up with the “dot plot” of Fed policymakers’ forecasts for future interest rates. If the move delays full easing until the upcoming meeting and expresses confidence in the economy, the market may dismiss the move immediately.
Some believe signs of dissonance in the dot plot could be significant — especially if it signals the Fed is easing less than some policymakers expect.
Of course, people will also look at the so-called long-term point, where interest rates were recently at 2.8%. Because this is widely viewed as Fed officials’ estimate of a durable “neutral” rate that would neither stimulate nor slow the economy, it is important in calculating the Fed’s thinking on the extent of the cycle.
Before we get there, the Treasury market has calmed down a bit – two-year yields have risen above 3.60% – more than 10 basis points above the two-year low hit on Monday. That was enough to lift the US dollar index (.DXY) temporarily off this year’s low and above 141 yen.
Japanese trade data was disappointing, with both exports and imports lower than expected, putting further pressure on the yen.
Global stock markets were overall mixed, in line with Wall Street futures.
Europe underperformed, with UK stocks (FTSE) falling and sterling rising above $1.32 as the Bank of England is not expected to follow the US Federal Reserve’s lead on Thursday and press ahead with its second budget of the year after the new Labour government presented its first budget interest rate cut.
UK inflation remained stable in August, but a pick-up in the services sector, which the Bank of England monitors closely, further strengthened the outlook. While overall inflation remained stable close to the 2.2% target, services inflation rose to 5.6%, higher than expected.
But what may get most attention on Thursday is the Bank of England’s latest annual forecast for the decline in its bond balance sheet – it is widely expected to cut its target by £100 billion over the next 12 months, as it did last year. However, the potential upside for the bond market is that a repeat of the target will mean a 75% reduction in active gilt selling, as huge amounts of maturing debt will be automatically let to mature.
There was very good news on inflation out of Canada on Tuesday , with the consumer price index (CPI) reaching the central bank’s 2% target in August, lower than expected and fueling speculation that the Bank of Canada would cut interest rates by 50% next month.
Key developments after Wednesday that will provide further direction to US markets:
* The Fed’s Federal Open Market Committee announced policy decisions, including quarterly economic forecasts and Fed Chairman Powell’s press conference
* US housing starts/permits in August, foreign debt holdings in July TIC data
*Brazilian central bank policy decision
* International Monetary Fund’s First Deputy Managing Director Gita Gopinath speaks in Ireland
* US Corporate Profits: General Mills
The views expressed are solely the author’s own. They do not reflect the views of Askume News, which is committed to integrity, independence and non-partisanship in accordance with the principles of trust.
