(Bloomberg) — Wall Street traders have stoked expectations that the Federal Reserve will cut interest rates by half a percentage point next week, prompting a shift into stocks that would benefit most from any policy easing.
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Economically sensitive stocks outperformed the group of tech mega-caps that led the bull-market rally, with the Russell 2000 index of smaller companies rising 2.2%. An equally weighted version of the S&P 500 — where companies such as Nvidia Corp. carry the same weight as Dollar Tree Inc. — beat the U.S. stock benchmark. That measure is less sensitive to earnings from the largest companies — offering a glimmer of hope that the rally will broaden.
As the S&P 500 rallied from record high to record high in the first half of the year, some investors worried that only a handful of members outside the tech giants were getting in on the rally. Corners of the market outside the big tech companies are surging as investors grow increasingly confident that the onset of the Fed’s cutting cycle will continue to fuel Corporate America.
“The biggest news in the last 24 hours was the shift in odds for a 50 basis point cut at next week’s Fed meeting,” said BTIG’s Jonathan Krinsky. “Small caps offer a better risk/reward in the near term and I think mega-cap tech is likely to get another breather, although it will certainly participate if the S&P 500 makes new highs.”
The S&P 500 rose 0.6%, while the equal-weighted version gained 1%. The Nasdaq 100 rose 0.4%. The Dow Jones Industrial Average rose 0.8%. Two-year Treasury yields fell four basis points to 3.6%. The dollar fell. Gold reached another record high.
Cantor Fitzgerald’s Eric Johnston says there’s a “very good” setup for small caps in light of the Fed’s decision. That’s the group seen as the most positive lever for a policy easing cycle, he noted, noting that the Russell 2000 has largely underperformed the S&P 500 in recent weeks.
“The consensus is the Fed will cut 25 bps, but of course there’s a chance they end up cutting 50 bps,” Johnston said. Small caps “would rally significantly if it was 50 and still rally at a very dovish 25,” he noted.
Stock markets are likely to continue moving sideways until U.S. jobs numbers show clear signs of weakening or strengthening, according to Bank of America Corp. strategists.
The team led by Michael Hartnett said there are several market factors at play that support both bullish and bearish narratives. While the optimists say technology and semiconductor stocks — including this year’s leader, Nvidia Corp. — have bounced off key technical levels, the pessimists warn that “nothing good happens” if bond yields and bank stocks fall at the same time.
On Friday, figures showed that US consumer confidence rose to a four-month high, while near-term inflation expectations fell to their lowest level since late 2020.
A steeper pace of austerity is consistent with growing concerns about a more pronounced slowdown in the labor market. While the latest inflation figures showed a slight increase in August, the core personal consumption expenditures index — the inflation measure the Fed tracks — is expected to be softer.
Countdown to the Fed meeting:
Yes, it is a tough climb, but I think the Federal Reserve will cut its policy rate by 50 basis points at its upcoming meeting. The argument for doing more immediately is strong.
A popular reason for not going 50 is the message it would send. “The Fed must know something the rest of us don’t,” goes the thinking. I don’t believe that for a second.
There are risks to the market if the Fed goes only 25%, especially given the unlikely threshold of a “dove-like cut” that would be reached. So a “how-the-market-would-react” argument doesn’t feel compelling. My own sense is that markets would welcome the move.
Just as we have put next week’s 50 basis point rate cut on the back burner, talk of 50 basis points has resurfaced.
While we originally called for a 50 basis point cut — and we think a 50 cut is the right thing to do — we just can’t imagine this Fed, which is so stuck in backwards numbers, getting to 50. The consensus view of Jerome Powell is that he’s not going to have enough votes to get to 50. So his strategy is going to be to go to 25 and then be uber dovey, in the press conference. That’s what we think, rather than what we want.
Judging by the price action, investors are certainly looking for a dovish rate decision. This could take the form of a surprise 50 basis point cut — or 25 basis point cut, with a strong hint of at least one 50 basis point cut in the remaining two meetings later this year.
It’s all about economic growth and the labor market now. You would think that after the higher inflation numbers, the implied probability of a 50 basis point rate cut would have fallen to zero. In fact, it fell to almost zero, but it has since recovered and we are back to square one. This implies that the probability of a 25 basis point or 50 basis point rate cut next week is evenly split.
And here’s the problem: now that the market is once again pricing the 50 basis point cut as equally likely as the 25 basis point cut, anything short of 50 will disappoint market prices.
We continue to maintain that an initial quarter point cut is the path of least resistance, although it is clear that 50 basis points is on the table and will be part of the Fed’s conversation. We recognize that CPI and PPI will likely lead to a more favorable move in core PCE. As the Fed’s preferred measure, the overall inflation profile will appear less concerning to policymakers and therefore allow the FOMC to focus on the labor market.
The decision to cut between 25 and 50 basis points could be closer than most people expect. In our view, the dot plot will be the most prominent part of the Fed’s guidance next week, along with Chairman Jerome Powell’s press conference after the meeting. Our expectation for the Fed’s forward guidance is that it will be dove-like overall.
Treasuries will focus on the size of the cut, the dot plot and Powell’s comments as key guidance. Given our expectation that the Fed will sound a generally dovey tone while delivering a 25bp rate cut to kick off the cycle, rates could continue to rise and the curve could continue to rise. We favor buying dips in duration.
Company highlights:
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Adobe Inc. presented a forecast that failed to quell investors’ impatience to see new artificial intelligence tools emerge.
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Oracle Corp. said annual revenue will rise to at least $104 billion in fiscal 2029, a bullish signal about the growth prospects of the software maker’s cloud infrastructure business. The company’s shares rose, hitting record highs.
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Boeing Co. factory workers walked off the job for the first time in 16 years, halting production at the planemaker’s Seattle plant after members of the largest union voted overwhelmingly to reject a contract offer and go on strike.
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Energy company Halliburton Co. was downgraded to sector perform from outperform by RBC Capital Markets.
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Furniture retailer RH reported second-quarter revenue and profit that beat Wall Street expectations. The company touted an improvement in customer demand in recent months, though it cut its full-year sales forecast, saying revenue will lag demand as it tweaks its inventory.
Some of the major moves in the markets:
Shares
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The S&P 500 rose 0.6% at 10:51 a.m. New York time
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The Nasdaq 100 rose 0.4%
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The Dow Jones Industrial Average rose 0.8%
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The Stoxx Europe 600 rose 0.9%
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The MSCI World Index rose 0.7%
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Bloomberg Magnificent 7 Total Return Index rose 0.4%
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The Russell 2000 Index rose 2.2%
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S&P 500 Equal Weighted Index rose 1%
Currencies
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The Bloomberg Dollar Spot Index fell 0.4%
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The euro rose 0.1% to $1.1089
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The British pound rose 0.2% to $1.3153
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The Japanese yen rose 0.8% to 140.69 per dollar
Cryptocurrency
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Bitcoin rose 0.3% to $58,346.76
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Ether rose 0.5% to $2,363.69
Bonds
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The yield on 10-year government bonds remained virtually unchanged at 3.67%
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The German 10-year yield remained virtually unchanged at 2.16%
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The UK 10-year yield remained virtually unchanged at 3.77%
Raw materials
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West Texas Intermediate crude rose 1.6% to $70.07 a barrel
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Spot gold rose 0.8% to $2,578.23 an ounce
This story was produced with the help of Bloomberg Automation.
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