Yesterday, the Fed lowered its fed-funds target range for the first time in this expansion—by 0.25 percentage point to 2% – 2.25%—and ended its scheduled balance sheet reduction two months earlier than planned. The S&P 500 dipped -1.1% on the day—not much, really—but enough to set off a major tizzy among financial pundits.[i] This snippet from a Wall Street Journal article sums up the common interpretation of stocks’ reaction and the rate cut’s significance: “Stocks fell, Treasury yields rose and the dollar strengthened after the Fed decision was announced, and during Mr. Powell’s news conference, apparently because many investors were disappointed the rate cut wasn’t bigger or that he didn’t firmly signal more reductions to come.”[ii] This indicates to us folks still credit Powell & Co. with sustaining this expansion and bull market—a false narrative we think stores up positive surprise ahead.
As we wrote in our 6/5/2019 piece, “No, the Fed Doesn’t Need to Cut Rates, But …,” a rate cut probably wasn’t necessary. Sure, this means the 10-year minus fed-funds rate’s shallow inversion is now even shallower, but this probably just diminishes banks’ interest rate arbitrage opportunities—they might borrow a bit more at home and a bit less abroad to fund lending here. Then again, if the ECB also cuts rates in its next meeting—as several ECB board members have hinted—the US/eurozone interest rate difference would revert to pre-Fed cut levels, restoring said arbitrage. In other words, the eventual impact is likely zero sum. As regards the Fed’s ending its balance sheet wind-down now rather than two months from now, we see this as mostly symbolic. The wind-down’s pace was too slow to meaningfully impact the market for Treasurys anyway.
Markets’ supposedly sour reaction strikes us as a typical “buy the rumor, sell the news” situation—it shows the rate cut was priced in beforehand, and that is about it. We wouldn’t read into it. Plus, this is just one day! Even if the narrative of market disappointment were correct, it wouldn’t be actionable for investors, as it doesn’t automatically signal further declines. By this logic, initial market dips in the aftermath of Brexit and President Trump’s election ought to have ushered in prolonged slides. They didn’t.
While events like Fed meetings can move markets in the short term, ascribing precise reasons to volatility is often more Rorschach test than sound financial analysis—revealing more about those brainstorming possible reasons than about markets’ true drivers. In this case, we think headlines’ reaction shows investor sentiment is still quite blah.
One last thing: We see this as another case of folks making waaaaay too much of Fed moves. As we have written here and here, Fed members don’t have the economy or markets on a string. Stocks and this expansion are much more resilient than this erroneous narrative gives them credit for. Given stocks move on the gap between reality and expectations, the disconnect seems pretty bullish to us.
[i] Source: FactSet, as of 8/1/2019. S&P 500 Total Return Index percent change, 7/31/2019.
[ii] “Fed Cuts Rates by a Quarter Point in Precautionary Move,” Nick Timiraos, The Wall Street Journal, 7/31/2019. https://www.wsj.com/articles/fed-cuts-rates-by-a-quarter-point-ends-portfolio-runoff-11564596200
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