Displaying items by tag: fed
The market has the idea that the Fed holds a massive “put”. The concept entails that the Fed can effectively set a floor on asset prices because it can take dovish action to support markets at any point. However, that notion is problematic at the moment because a rate cut in the near term may actually induce a correction. In fact, markets look set for a lose-lose scenario. On the one hand, if the Fed does not cut rates, markets will be very disappointed and slump. On the other hand, investors have already priced in a near 100% chance of a rate hike, so it happening won’t give markets much of a boost and is more likely just to make investors worry that the economy is headed south.
FINSUM: We hate to say it, but we kind of buy into this view. Maybe not so much that markets will fall even if the Fed cuts rates, but the cuts certainly won’t be overly supportive at this point and may lead to a gradual decline.
We know, we know, a mortgage meltdown sounds like a claim coming out of left field. However, it comes from a potentially big issue that no one is paying attention to—the fact that the Fed is winding down its massive $1.6tn+ mortgage bond portfolio. As the Fed has begun to unwind its MBS portfolio, there are growing worries over the economy and real estate market. This could lead to a mortgage shock. Spreads between MBS and Treasuries have already risen as investors have grown nervous about oversupply.
FINSUM: So this is more of a technical issue than a fundamental one, but given the confluence of negative sentiment and oversupply, there is certainly some significant risk on the horizon for MBS.
There was a lot of anxiety yesterday about what the Fed might do. The big banks were taking the opposite side of markets, saying that the pace of rate cuts that investors expected were unrealistic. Then Fed chief Powell spoke and it became clear that markets were right, the Fed is completely dovish and has fallen in line with investor expectations. Powell signaled that rate cuts were on the immediate horizon, which has led markets to up their odds-making of a rate cut in July to 100%.
FINSUM: Powell was about as dovish as a central banker ever gets short of the middle of a crisis. For us this is quite an unusual situation—an economy doing well with both of the Fed’s dual targets being met, yet there is an undeniable sentiment towards cutting rates.
There is a lot riding on the results of the Fed’s meeting this week. Every big bank is weighing in and the consensus is that the markets have gotten too dovish in their projections and that the Fed won’t cut now, or as quickly as investors expect, all of which will lead to a decline in stocks. Both UBS and Goldman think that the pace of rate cuts forecasted by markets would only make sense in a recession, which seems unlikely. Morgan Stanley says stocks are very vulnerable to a decline if the Fed doesn’t cut as it will shift expectations and lead to tighter conditions. JP Morgan thinks equities will decline even if the Fed does cut.
FINSUM: We think the Fed will stay on hold for now but signal cuts in the Fall. We expect this will have a neutral to mildly negative effect on share prices.
You may normally think of it in terms of stocks, but “buy low, sell high” applies to bonds just as much, and that is a good way to think of the market right now. With yields having fallen so far since last year, one strategist said it was time to accept the “the present the Fed has given us”, and swap out bonds for floating rate securities, which have lagged this rally. The scale of returns in the bond market is impressive. For instance, the iShares 20+ year Treasury Bond ETF has risen over 9% since the beginning of the year.
FINSUM: It seems unlikely to us that bond yields are going to drop much further, which means there is little reason to wait for further gains.