Fed Follow-Up: Markets Don't Appear To Get Rate Cut Boost As Fed Doesn't Promise More

A widely-expected rate cut from a divided Fed doesn’t seem like enough to give the market much of a lift, at least judging from weakness in futures early Thursday.

After the Fed cut rates 25 basis points yesterday, focus now could turn back toward the stuff everyone was talking about before the Fed interruption. That means China trade, Brexit, and U.S. consumer health. On the China front, U.S. and Chinese negotiators are sitting down today to pave the way for next month’s trade talks. In other news, the Bank of England voted unanimously to keep rates unchanged., and the Bank of Japan kept rates steady, too.

The S&P 500 Index (SPX) has been trading roughly between 2800 and just above 3000 for a long time, and nothing the Fed said or did yesterday appears likely to change that. There would probably have to be some sort of significant news on the trade front one way or the other for stocks to bust out of that range.

Meanwhile, Treasury yields are back-tracking a bit this week after the 10-year rose to 1.9% a week ago. They were down again early Thursday, with the 10-year now below 1.8%. That’s still way above a month ago, but it does look like the yield rally is taking a pause. That could mean some caution creeping back in.

There’s data to watch this morning as existing home sales for August are due. Yesterday’s building permits and housing starts data looked really solid, so maybe the low rates and consumer resilience is starting to show in a healthier housing market.

No “Pre-Set Course” For Future Rate Policy

The benchmark fed funds rate is now in the 1.75% to 2% range, back to where it was roughly a year ago. It feels like the Fed is pedaling madly to keep the long U.S. expansion going even as economies in Europe and Asia seem to be slipping into slow motion.

It looks like rate policy will remain a “meeting by meeting” decision based on data and the risk picture, Fed Chairman Jerome Powell said in his press conference, adding that there’s no “pre-set course.”

This might have disappointed bulls who’d been hoping for more dovish words, but let’s face it: Anyone who really thought Powell would change his tune and say something more dovish probably hasn’t been following things too closely the last few months.

Powell’s press conference on Wednesday showed that the Fed chair remains relatively cautious, and that he’d rather watch the data come in before hinting at next moves. Brexit and the China trade situation both could see new developments between now and the end of next month, when the Fed meets again. There’s also the September U.S. jobs report and the start of another earnings season, along with the first official government estimate for U.S. Q3 gross domestic product (GDP). It seems only natural for a Fed chair to not box themselves in when so much is hanging overhead.

Another thing to consider is that the Federal Open Market Committee (FOMC) remains divided over rate cuts. It was a 7-3 vote to lower rates 25 basis points this time, with two members wanting to keep rates where they were. That could make it tougher for Powell to push through another cut next month even if he wanted to (see more below). If he decides a cut is necessary, he’ll have to work up a case for it with the hawks who think the Fed has already gone too far.

As a reminder, the dot plot showed five members thinking the FOMC should have held its previous range of 2% to 2.25%, five approve of the 25 basis point cut but want to keep rates there through the rest of the year, and seven favor at least one more cut this year, CNBC noted. 

How did investors interpret the Fed statement and press conference? For those of you playing at home, let’s check the futures market. According to Fed funds futures at the CME Group, there’s now about a 45% chance of the Fed cutting again by 25 basis points next month, and a 55% chance of standing pat.

Basically, one of the Fed’s main messages seemed to be it’s going to continue letting the numbers tell it what to do next. That’s kind of where it was earlier this year. 

Want rates to rise? Maybe take a trip to Norway, where the central bank went against the grain today and hiked rates a quarter point to 1.5%. The Norwegian economy remains solid, the bank said.

A Different Type of Stimulus Potentially Eyed

Lack of a definitive promise for more rate cuts initially appeared to put stocks under pressure late in yesterday’s session, but the last half hour saw a major rebound (see Fig. 1 below). Stocks charged back to finish pretty much even on the day, perhaps partly because Powell said in his press conference that the Fed wouldn’t rule out a different type of monetary stimulus.

Recall that the central bank recently wrapped up a balance sheet reduction program, and already there have been calls for a fresh round of expansion. Powell seemed to heed those calls in the press conference. “It’s certainly possible we’ll have to resume organic growth of the balance sheet earlier than we had thought,” Powell said. 

Looking more closely at sector performance Wednesday, Financials were among the leaders as the Fed’s lack of promises about future rate cuts apparently raised hopes that banks wouldn’t see profit margins squeezed further. Utilities, known as a “defensive” sector, was tops on the leaderboard.

The SPX is up nearly 20% this year and just a hop, skip and a jump away from all-time highs. It arguably needs some kind of catalyst if it’s going to resume marching higher. It’s also only 3.5% above year-ago levels. Last year it peaked in late September and had a very rough Q4.

7-3 Isn’t a Baseball Score: It may sound like one, but in reality, it’s the score Wednesday at the Federal Open Market Committee (FOMC), where seven members voted to cut rates 25 basis points and three voted against. It’s interesting to see a growing dichotomy among Fed voters, with three of them dissenting this time around. One wanted a 50-basis point cut, while two wanted no cut at all. Dissenters included some of the usual hawks and doves.

This is the second time in a row we’ve seen people dissenting, which makes it seem like it could be tougher for the FOMC to reach consensus the next few meetings. It’s also the first time there were three dissents since 2016. What didn’t change from the last statement back in July is the Fed saying it will continue monitoring the economy, a possible sign that FOMC members could simply decide to watch the economic data roll in before deciding on next steps. It’s getting harder to reach a consensus at the Fed, and this is unusual historically. 

Hope Springs Eternal: Despite saying the Fed would explore the potential need for more stimulus, Powell remains relatively hopeful about the U.S. economy, one takeaway that may have been a bit overlooked yesterday. He said the FOMC still expects U.S. gross domestic product (GDP) growth to remain “moderate” at near 2% this year and next, and unemployment to stay below 4%. Powell says the labor market remains strong, with wages rising “particularly for lower wage jobs,” which is allowing more people to participate in the job market. This could be one factor behind the rate cuts, because Powell wants to keep the expansion going for those at the bottom end of the job and wage picture. He doesn’t see a recession or negative rates ahead. 

The Almighty Dollar’s Case for a Cut: It all comes down to dollars and cents, as the saying goes. Maybe today’s Fed rate cut works into that old expression, because one argument for easing rates involves the strong dollar and how to get it back down. At this point, with the dollar index not far from recent highs above 99, it could be creating concerns about future U.S. growth. A strong dollar combined with weakness in overseas markets could hurt the U.S. economy from an export perspective by making its products cost more even as economies overseas grapple with possible recession.

The Fed has said it wants to keep the U.S. expansion going and also wants to get inflation back to its 2% target. By lowering rates, it could conceivably weaken the dollar and spark some inflation by influencing companies and consumers to spend more, though that’s just theoretical. The other problem is, no matter what the Fed does or says, the dollar hasn’t budged much in recent months. It tends to be one of the places people go when there’s a “flight to safety,” meaning even if rates go down (theoretically creating a higher supply of greenbacks), people might still want to be long dollar for perceived protection, as the U.S. economy still looks like the best house in a bad neighborhood. The dollar rose after yesterday’s rate cut.

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