Lean on me! Stocks rallied moderately yesterday as the Fed reassured traders that rate cuts could come soon. The Federal Reserve took a reserved approach and kept rates unchanged but made it quite clear that they are leaning towards future rate cuts.
MY TWO CENTS
- What exactly did the Fed give us yesterday? While it was largely expected that the Fed was not going to cut rates at yesterday’s meeting, many traders still harbored secret hopes that maybe, just maybe, something big might happen. Well, in typical Fed fashion nothing big happened as they tweaked their message to send an important message to the market: we are here for you. The first sign of a change was the removal of the word “patient” from the policy statement, which can be interpreted that the time for patience is over and that action is warranted. In Powell’s comments, he spoke of increased global economic “cross currents” caused by trade conflicts. Further, he stated that the committee would monitor economic conditions and act appropriately to sustain the expansion. That means: we will cut rates if things don’t get better. The last bit of important data came in the Dot Plot which conveys the Fed Governors’ projection for rates in the future. According to the plot, 8 governors expect rates to go down by 1 or 2 cuts this year while 9 expect rates to remain unchanged and 1 expects rates to go up. The mean forecast says rate will remain unchanged this year, but the fact that 8 governors are already in the rate cut camp is a positive sign for traders placing hopes on lower rates. According to Fed Funds futures, there is now a 100% probability of a rate cut in July while just one month ago the probability stood at only 20%.
- Currency weakness paves the way for hardball tactics. One of the many reasons President Trump wants the Fed to lower interest rates is to give him bargaining power in his ongoing trade campaign. When rates go down, demand for sovereign bonds goes down which in turn drives down local currency as foreign investors must purchase dollars to buy dollar-denominated treasuries. A weaker dollar means that US goods bought by foreign buyers are cheaper which gives the US trade strength against its trading partners. The administration is quite conscious about this economic calculus and just the other day the President lamented via Twitter at the dovish words from ECB President Mario Draghi as the Euro weakened and strengthened the US dollar. Yesterday’s dovish words from the US central banks gave the President what he wanted: the dollar fell strengthening his position in trade talks with China. Traders who are fearful that a China deal may not happen soon should be worried that the weakened currency gives the President more reason to stay tough.
Stocks posted modest gains as the Fed did not exactly dazzle with a rate cut but instead left investors with confidence that the central bank will do what is right for the markets. Though the market initially had a muted response, the slight policy shift is positive for markets going forward. The S&P500 traded up by +0.3%, the Dow Jones Industrial Average climbed by +0.15%, the Russell 2000 advanced by +0.35%, and NASDAQ 100 jumped by +0.42%. Bonds advanced and 10-year treasury yields fell by -3 basis points to 2.02%.
– The Conference Board will release its Leading Index which is expected to have grown by +0.1% compared to last month’s +0.2% growth.
– Darden Restaurants will announce earnings before the bell and RedHat will release after the close.
– Canadian President Justin Trudeau will be in Washington today
– WHILE YOU SLEPT, 10-year yields went below 2% but have since bounced back over the important level. Crude oil prices jumped in response to reports that Iran shot down a US drone in the Gulf.