By Saqib Iqbal Ahmed, Suzanne McGee and Carolina Mandl
NEW YORK (Reuters) – Investors expecting furious market swings after the U.S. Federal Reserve’s massive rate cut saw a more muted reaction, which could be fleeting.
Traders faced a lot of 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 a percentage point.
But while market reaction was muted, with stocks and the dollar reversing positions to close the loop, a new wave of action could be coming. Some specifically pointed to the risk of bond yields surging after Wednesday’s surge.
“The calm won’t last long,” said Brian Jacobsen, chief economist at Annex Wealth Management, which manages $5.5 billion in assets. He pointed to a turnaround in stocks by the end of the day, which could saddle the market with weakness in equities “unless and until we get some data that gives us a clear sense of direction.”
According to Jacobsen, the market will focus on upcoming data, such as initial jobless claims on Thursday.
“The Fed is clearly playing catch-up and trying to make up for lost time with the rate cut they just made,” Jacobsen said.
There could also be a domino effect if the Fed’s decision ripples through to other markets.
“The coming hours could prove dangerous … traders are exposed to sudden surges as interest rate expectations in other economies strengthen,” Karl Schamotta, chief market strategist at payments firm Corpay, said of currency markets.
“There will likely be further aftershocks as positioning adjustments take place.”
DAMPED REACTION
Stock options had priced in about a 1.1% swing, up or down, for the S&P 500, according to options analysis service ORATS. But by the end of trading, the index had snapped a seven-day winning streak and ended down 0.29%, erasing earlier gains.
One reason for the muted market 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 Carson Group. Through Tuesday, the Russell 2000 was up 5% from the previous five sessions and the dollar was down 0.7% on expectations for the start of the Fed’s long-awaited rate-cutting cycle.
“It’s a really stupid cliché: ‘buy the rumor, sell the news,’ but that’s what happened,” said Matt Diczok, head of fixed-income strategy at Merrill and Bank of America Private Bank.
On Wednesday, the dollar index initially fell but then recovered and rose 0.1% to 100.981.
“Given that this policy change was largely announced, there is no outsized change in financial markets,” said Jack McIntyre, portfolio manager at Brandywine Global.
Bonds, however, did see a significant move, with the 10-year yield rising seven basis points on the day, while the 2/10 US Treasury yield curve reached its steepest level since July 2022, following the rate cut, signaling expectations of higher inflation and growth in the long term.
Government bond yields, which move inversely to prices, had fallen to their lowest level since mid-2023 in the days leading up to the decision.
In a research note, Julian Emanuel, senior managing director at Evercore ISI, advised positioning for a rise in yields and that the Fed’s progress on inflation could slow or even stall.
Small caps, which initially rallied, ended flat. The initial reaction from traders was to send the small-cap-focused Russell 2000 index up nearly 1% in the minute immediately following the Fed’s decision, marking the index’s biggest one-minute percentage gain in at least three months, according to LSEG data.
Smaller businesses tend to rely more on loans. Lower interest rates reduce their financing costs, which helps their profitability and growth.
“If we look specifically at the jump in small caps, it means the market believes what the Fed is saying, that they are going to continue to cut rates next year and that is a potential tailwind for small caps,” said Ryan Detrick, chief market strategist at Carson Group.
But the Russell index rose only 0.04% that day.
Fed Chairman Jerome Powell said at the meeting that the rate cut marks a “strong start” to protecting the economy’s strength.
Yet the excessive rate cut can be seen as even more alarming.
“I think investors who are entering the intraday stock market to play this event will take a lot of profits. We may well end up trading lower as the market continues to wonder what the Fed is scaring us and what we can’t see,” said Matthew Rowe, head of portfolio management and cross-asset 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)
