New highs, spin as Fed meets retail health check by Reuters

(Reuters) – A look at the day ahead in US and global markets from Mike Dolan

With Federal Reserve easing just around the corner, U.S. stocks are unsteady, underscoring an uncomfortable aspect of this week’s central bank decision.

Amid a fresh rotation of sectors from megacaps to small, the equal weight, which adjusts the main index to remove the overwhelming influence of a few giant stocks, hit a record on Monday.

This index is now up more than 11% for the year and nearly 20% over the past 12 months, showing that market abundance is no longer the exclusive preserve of the “Magnificent Seven” of Big Tech leaders or just the theme of artificial intelligence.

But as the Fed begins its two-day meeting on Tuesday and mulls the size of its first rate cut this cycle, the general easing of financial conditions caused by that kind of market optimism could play a role in keeping it cautious.

The Chicago Fed’s broad index of financial conditions, for example, is now the weakest since November 2021.

Could the Fed just think the market is relaxing and stick to a modest 25 basis point cut for good measure?

The “25 or 50” debate remains the only focal point for Wednesday’s announcement, and speculation ahead will clearly shape how the markets themselves will react to the Fed’s delivery.

Right now, Fed futures are leaning toward a 50 basis point move, with about 42 basis points expected early Tuesday and 120 basis points seen through the rest of 2024.

Morgan Stanley strategists, for example, believe much of the reaction to the eventual outcome will depend on what the Fed’s latest “plot” of future policy rate forecasts indicates.

If the Fed only cuts by a quarter and there are no individual policymakers’ projections for more than 75 basis points by the end of the year, they say, that could be bullish for risk assets, showing a consensus that the economy has need more than that.

Another bullish scenario, according to the investment bank, is a cut of 50 basis points, with some seeing less than 75 basis points by 2024 — a sign the Fed isn’t sure the economy needs up to 50 base points, but he’ll get it anyway.

Flip them all for more negative scenarios.

And it appears that a 50 basis point cut is not out of the question, regardless of the level of dissent within the committee.

Former New York Fed chief Bill Dudley last week called for a 50-basis-point move to head up the cooling labor market. And White House adviser and former Fed vice chairman Lael Brainard also emphasized that Monday, saying “it’s important to protect the important progress we’ve made in the labor market.”

Markets remained buoyant on Tuesday as the Fed is set to do its last economic check before the call, with August retail sales and industrial production figures due out later.

The benchmark S&P500 at a flash of record highs is matched by two-year Treasury yields hovering around two-year lows of 3.55% — more than 180 bps below the Fed’s current policy rate. The two- to 10-year yield curve remained marginally positive, up around 6 bps.

The stock volatility indicator was reduced to 17 just below long-term medians.

And it has lost weight again and is just a hair away from its lowest level of the year.

With Japanese markets open again on Tuesday, the dollar/yen tried to get its feet back above 140, but the yen’s latest rally this week to its best level in 15 months troubled the stock index. The index lost more than 1% at the reopening.

European stocks were firmer as central bank easing on the continent is already underway and expected to continue.

LAGGING TECH

Elsewhere, the action was in Big Tech, which performed strongly on Monday.

Apple (NASDAQ: It held steady overnight, however, and S&P500 stock futures rallied smartly before the bell.

There was better news for Intel (NASDAQ: ), which rose 6% on Monday after it qualified for up to $3.5 billion in federal grants to make semiconductors for the U.S. Department of Defense. It then extended those gains after the bell as its contract manufacturing business signed up Amazon’s (NASDAQ: ) cloud services unit as a customer to make custom AI chips.

Microsoft (NASDAQ: ), meanwhile, said its board approved a new share buyback program of up to $60 billion and a 10% increase in its dividend.

Key developments that should provide more direction to US markets later on Tuesday:

* August US Retail Sales, Industrial Production, September NAHB Housing Index, July Business/Retail Inventories; Canada August CPI inflation

* The Federal Reserve’s Federal Open Market Committee begins a two-day policy meeting, decision on Wednesday

* The US Treasury is selling $13 billion worth of 20-year bonds

(By Mike Dolan, Editing by XXXX; [email protected])