U.S. Federal Reserve Chairman Jerome Powell will have to walk a fine line to avoid roiling the stock market next week, even if the central bank delivers on expectations and lowers interest rates for the first time in more than a decade.
Investors are betting that the Fed most likely will cut the federal funds rate by 25 basis points to a range of 2.00 per cent to 2.25 per cent at the end of its two-day meeting on July 31. Whether that kicks off the first full-blown rate-easing cycle since September, 2007, when the financial crisis was starting to build, or a more limited spurt of “insurance” cuts, is far from clear.
Regardless, the S&P 500 has a history of rising in the months following the onset of Fed cutting cycles, even the pair of mini-cycles in the mid-1990s.
But with the benchmark index already up 20 per cent year-to-date, partly attributed to rate-cut expectations, a quarter-point cut may not be enough to expand on or even sustain 2019’s gains. Instead, the market will look to Mr. Powell’s view on the economy and hints about his appetite for further cuts.
“You’ll see a lot of volatility from the announcement through the end of the press conference because investors are going to parse every single word,” said Paul Nolte, portfolio manager at Kingsview Asset Management in Chicago.
Many are looking for Mr. Powell to signal more rate cuts. For example, if he says his next steps will be guided by numbers, this may suggest an open mind about future cuts, says TD Ameritrade chief market strategist JJ Kinahan. But if the Fed chief also comments on progress made in the economy, this may erode easing hopes.
“We’re limited on the upside, but he could say a lot of things that are received poorly. What he says and how it’s interpreted could be what disappoints,” Mr. Kinahan said. “Every word has to be perfect. That’s a tough line to walk.”
Friday’s stronger-than-expected reading of second-quarter U.S. gross domestic product will certainly add weight to the argument that a full-on easing cycle may not be warranted for now. How Mr. Powell characterizes the Fed’s actions against that backdrop is key.
Quincy Krosby, chief market strategist at Prudential Financial in Newark, N.J., says investors will look for Mr. Powell to mention “cross-currents” from trade again and to say he will do what he can to keep the expansion intact.
Even so, “you may see after the meeting that the market takes a breather and consolidates as it waits for the next catalyst,” said Mr. Krosby, who sees a U.S.-China trade deal as the next big catalyst.
Even if the short-term reaction is muted next week, history shows a positive longer-term trend for stocks after the commencement of a rate cutting cycle.
Going back to 1954, the S&P 500 rose an average of 14 per cent in the 12 months after the Fed started a rate-cutting cycle, according to Audrey Kaplan, head of global equity strategy at Wells Fargo Investment Institute.
The S&P fell in the 12 months following the start of just three of 16 easing cycles. In two of those periods – 2001 and 2007 – the economy was already on the cusp of a recession when the cycle started, according to Ms. Kaplan. But she doesn’t see a recession on the horizon this time. Instead, she is hoping for an economic boost from a rate cut or from signals of further cuts.
“Rates are very low this cycle. It’s very different from the other cycles but the low and going lower rates could be good for the expansion of the economic cycle,” she said.
Interest-rate traders are betting that a rate cut of at least 25 basis points is a certainty, according to CME Group’s Fedwatch. They have priced in a 19.4-per-cent probability of a 50-basis point cut, which would drop the Fed’s target rate range to 1.75 per cent to 2.00 per cent.
While some investors would welcome a 50-basis-point cut on Wednesday, others worry that the Fed would cut by two notches only if it is seeing something more ominous in the economy.
“The market doesn’t like surprises. It might initially rally, but with such a low probability, the longer-term question would be: ‘What are you seeing that we don’t see?’ ” Ameritrade’s Mr. Kinahan said.