Excessive Fed rate cuts draw weak reaction, but calm may not last

By Saqib Iqbal Ahmed, Suzanne McGee and Carolina Mandl

NEW YORK (Reuters) – Investors who had anticipated furious market swings following the U.S. Federal Reserve’s flash rate cut saw a more muted reaction. It may be transient.

Traders faced high uncertainty as they awaited Wednesday’s expected rate cut, with a split between those expecting 50 basis points and 25 basis points. The Fed cut rates by an unusually large half-percentage point.

But while the market reaction has been quiet, with stocks and the dollar reversing positions in most of the full circle, there could be another wave of action. Some pointed specifically to bond yields that are at risk of rising after Wednesday’s rise.

“I think the calm is not going to last,” said Brian Jacobsen, chief economist at Annex Wealth Management, which oversees $5.5 billion in assets. He pointed to a reversal in stocks later in the day that could set the market for weakness in stocks “unless and until we get some data that gives us a clear sense of direction.”

Jacobsen said the market will focus on upcoming data, such as Thursday’s initial jobless claims.

“The Fed is clearly in catch-up mode and trying to make up for lost time with the tapering it just did,” Jacobsen said.

There may also be a knock-on effect as the Fed’s decision spreads to other markets.

“The next few hours could prove dangerous … with traders exposed to sudden swings as rate expectations tighten in other economies,” Karl Schamotta, chief market strategist at payments company Corpy, said of currency markets.

“Aftershocks are likely to continue as positioning adjustments take place.”

DUMB REACTION

Stock options were up or down about 1.1% for the S&P 500, according to options analysis service ORATS. But by the close, the index snapped a seven-day winning streak to end up 0.29 percent, reversing earlier gains.

One reason for the market’s weak reaction on a close-to-close basis has to do with how asset prices moved in the days leading up to the Fed’s decision, said Sonu Varghese, global macro strategist at the Carson Group. By Tuesday, the Russell 2000 was up 5% over the previous five sessions and the dollar was down 0.7% on expectations of the start of the long-awaited Fed rate cut cycle.

“It’s a very silly cliché, ‘buy the rumor, sell the news,’ but that’s kind of what happened,” said Matt Diczok, head of fixed income strategy at Merrill and Bank of America Private Bank.

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On Wednesday, the dollar index fell initially but recovered to trade up 0.1% at 100.981.

“Since this policy move has largely been telegraphed, there is no excessive movement in the financial markets,” said Jack McIntyre, portfolio manager at Brandywine Global.

Bonds saw a significant move, however, with the 10-year yield rising seven basis points on the day, while the 2/10 U.S. Treasury yield curve hit its steepest level since July 2022 after the rate cut, signaling in the long term. higher growth and inflation expectations.

Treasury yields, which move inversely to prices, fell to their lowest levels since mid-2023 in the days before the decision.

In a research note, Julian Emanuel, senior managing director at Evercore ISI, recommended positioning for a rise in yields and that the Fed’s progress on inflation could slow or stall.

Small capsules that initially bounced ended up flat. Traders’ initial reaction was to push the small-cap Russell 2000 up nearly 1 percent in the minute immediately after the Fed’s decision, marking the index’s biggest one-minute percentage gain in at least three months, according to LSEG data.

Smaller companies typically rely more on borrowing, and lower interest rates lower their financing costs, increasing their profitability and growth.

“To see the growth in small caps in particular, that’s the market that’s buying what the Fed is saying, that they’re going to continue to cut rates next year, and that’s a potential tailwind for small caps,” said Ryan Detrick, chief strategist at market at Carson Group.

But the Russell ended up just 0.04% on the day.

Fed Chairman Jerome Powell said at the meeting that the rate cut marked a “strong start” to safeguarding strength in the economy.

However, the excessive rate cut could be read more alarmingly.

“I think there will be plenty of returns for investors who got into stocks throughout the day to play this event, and we may very well trade lower as the market continues to wonder what exactly is scaring the Fed that we can’t see it,” said Matthew Rowe, head of portfolio management and cross-strategies at Nomura Capital Management.

(Reporting by Saqib Iqbal Ahmed, Suzanne McGee and Carolina Mandl, additional reporting by Davide Barbuscia and Michelle Price, editing by Megan Davies and Rod Nickel)