As we warned earlier this week, never underestimate the Fed’s ability to out-dove the market. The FOMC delivered a 50-basis point cut to 5% (upper band) at the September meeting today (leaked by Timy from the Wall Street Journal). The initial read is dovish. Two additional 25 basis point cuts were priced for the remainder of this year and the dot-plot suggests more easing than previously expected by the end of 2025. The implication is that the Fed has maintained their asymmetry to the left tail (downside) risk for the economy and markets.
To be fair, we would argue that the funds rate is as much as 250 basis points above the neutral rate (prior to the policy easing today). Although one of the potentially hawkish observations from the press conference was the Fed Chairman’s suggestion that the neutral policy rate is higher than what it was in the pre-2019 regime. Tactically, our own sense is that the “super-sized” cut today might box the Fed in to larger 50 basis point cuts in November and December this year “if” the labour market deteriorates more sharply over the coming months.
As we have noted previously, the rise in unemployment from the trough and leading indicators of the labour market (job openings, temporary hires, consumer confidence net-jobs plentiful) is probably consistent with a non-trivial deterioration in cyclical conditions. Put another way, more aggressive policy easing (relative to what is already priced) might be warranted over the coming months.
While the initial reaction was dovish, there has been so much priced in, that there was not a lot of additional upside risk in fixed income markets and gold unless, as noted above, the Fed is forced to ease into much weaker labour market and macro conditions. Of course, if macro conditions remain resilient and the fiscal impulse remains large, Treasury bonds could be vulnerable to a re-acceleration in both growth and inflation momentum.
As we have noted previously, the start of the last two major rate cutting cycles; January 3rd, 2001, and September 18th, 2007, when the Fed eased by 50 basis points, the stock market declined by 39% and 54%, respectively (chart 1). In both episodes, the unemployment rate increased by 2.1% and 5.3% respectively and ended in recession. In the 2007 episode, the start of the rate cutting cycle also commenced with the equity market near the all-time-high. Macro imbalances and service sector growth momentum is more resilient today, however global cyclical conditions are more fragile from our perch. The late July, early August drawdown was probably just a preview or tremor ahead of a more challenging episode in October.
Chart 1
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