The Fed meeting yesterday was not what everyone expected. While the central bank did cut rates 25 basis points, the commentary was far from what investors expected. The attitude on the Fed had turned so dovish prior to the meeting that some thought Powell might cut rates by 50 bp. The whole meeting took a different course, with the Fed saying this was just a “mid-cycle adjustment” and refusing to commit to a further cutting plan. This upset markets, with indexes all diving over 1%.
FINSUM: We think this was smart from the Fed and ultimately good for markets. It left things more uncertain as to policy and direction, which means stocks will trade more on fundamentals. This reinstates the “wall of worry” that always seems necessary to build bull markets.
We are back in the weird world of the 2013-2016 era. Remember the time when weak/moderate economic news was great for stock prices? Welcome back. Investors are hoping that economic data trends flat or just a tiny bit weak, which would cause the Fed to loosen policy. However, if the economy does well, that would lead to tighter monetary conditions, which investors don’t favor. Therefore, right now, bad economic news is good for the market, and vice versa.
FINSUM: We have always found these kind of “goldilocks” scenarios rather perverse, but they are the reality nonetheless.
Rate cuts are going to send shares higher and bond yields lower, right? A win-win for portfolios. Not so fast, as the effect a Fed cut will likely have on portfolios could be anything but predictable. The truth is that monetary easing is not the economic steroid it once was, and investors know it, so the odds of a pop in the market seem low. This is doubly true because much of the possible gain from rate cuts has already been priced in by the market due to how well the Fed has telegraphed this move. If any stocks should do well, it would be small caps, which are more reliant on borrowing and thus would gain the most from lower rates.
FINSUM: This cut has been so anticipated that it will likely be greeted by a shrug. If anything, we think there are more downside risks.
The broad expectation is that rate cuts will boost all bonds. To some degree this is likely true. However, not all bonds will be affected to the same degree. For instance, safe bonds—think investment grade corporates and Treasuries—have likely already seen most of the gains they will. But high yields are a different story, as they are much more likely to see a decent rally, as lower borrowing costs are a bigger boon to those companies and the cuts themselves will help sustain the economic cycle, which is more important for them than for ultra-safe companies.
FINSUM: This seems to be pretty good analysis. This rate cut has been widely projected and safe bonds have already seen gains, so junk may be the biggest beneficiary.
UBS just went on the record warning of a potential bursting bubble in equity markets. The bank’s CEO says that global coordinated central bank easing posed a threat to markets and risked inflating a bubble. “I’d be very, very careful about growing further the balance sheet of central banks”, said CEO Sergio Ermotti. He further explained that current market prices were out of sync with investor sentiment, posing a risk. However, he did say that clients were ready to buy the dips in the market, which was an encouraging sign.
FINSUM: The equity markets remind us a bit of US politics at the moment. There are a lot of people in the middle without a lot of conviction, but those on the sharper ends are driving the whole thing forward.