(Bloomberg) — Jerome Powell delivered exactly what Wall Street traders have long hoped for: a big rate cut that would justify this year’s strong rally in stock and bond markets as the era of tight monetary policy finally comes to an end.
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Stocks, particularly those of economically sensitive companies, briefly rallied, lifting the S&P 500 as much as 1%. Bonds did the same, while the prospect of easy money in the future initially boosted speculative assets like crypto.
But by the end of the day, the gains had disappeared as a more sobering economic and market reality began to sink in. Even with the half-point rate cut — the kind of aggressive move usually reserved for a recession or crisis — and more on the way, the investment backdrop was no clearer than before.
Stock prices are already near record highs. The economy is losing steam. And there’s no guarantee that the rock-bottom rates that were swept away by post-pandemic inflation will return anytime soon.
While stocks gained some momentum on Thursday and Treasuries rose modestly, all major assets fell on Wednesday. While the magnitude of the declines was small, such a concerted pullback had not been followed by a Fed policy decision since June 2021.
Traders were particularly concerned about Powell’s comments coinciding with the turnaround in stock and bond markets: No one should expect the Fed to make a habit of cutting rates by half a percentage point in the future, and the neutral level of interest rates is likely higher than before the pandemic.
“The key point here is that there is action, in the 50 basis points, and the expectation is in what was priced in,” Jeffrey Rosenberg, a portfolio manager at BlackRock Inc., said on Bloomberg Television. “This is a little disappointing relative to what has been built into bond expectations.”
In the aftermath, economists and traders adjusted their forecasts and bets to account for the Fed’s new narrative. Goldman Sachs Group Inc. forecast a longer streak of consecutive cuts, while economists at JPMorgan Chase & Co. reiterated their call for another half-point cut in November, citing jobs data as key to their view.
Powell was optimistic about the economy and dismissed recession fears, tempering market expectations about where it is headed. At his press conference, he said the central bank was confident that “the strength of the labor market can be maintained in a context of moderate growth and inflation falling sustainably to 2%.” At the same time, he cautioned against assuming that the half-point move would set a pace that policymakers would maintain — stressing that everything depends on how the data comes in.
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The bond market was already in the midst of a series of rate cuts, and bets on Wednesday’s move had grown so large that it had already been priced in. The two-year Treasury yield, for example, had already fallen from more than 5% in late April, enough to reflect several rate cuts.
“It was always going to be tough for Powell to outperform the bond market given how much it has moved over the past six weeks or so,” said Michael de Pass, global head of rates trading at Citadel Securities.
While the economy does not appear to be in clear need of stimulus, there are signs of a weakening trend. Average quarterly non-farm payroll growth is at its lowest level since 2020 and factory output indicators have fallen.
At the same time, the unemployment rate is just 4.2%, gross domestic product is forecast to grow at the same pace in 2024 as it did last year, and analysts are currently estimating a remarkably robust 14% in 2025 earnings growth for the S&P 500. That bullish backdrop had investors pushing stocks to near-unprecedented valuations just as the first rate cut came: more than 25 times earnings over the past four quarters.
That could reflect another anomaly in the current situation: The Fed has raised rates so high — about 5.3% before Wednesday’s move — that traders are confident there’s still plenty of room to cut rates if the economy falters.
“While we can all debate the justifiable speed of rate cuts, the reality is that the direction of policy rates is lower,” said Charlie Ripley, senior investment strategist for Allianz Investment Management. “The track record of this Fed has shown that they are not the fastest historically, but they have shown the ability to step up the pace when deemed necessary.”
However, traders have struggled to predict the Fed’s course as inflation has risen due to the pandemic. Plus, Powell is dependent on incoming data, meaning it won’t be any easier to predict the Fed’s course even now that it has changed course.
Policymakers have planned an additional percentage point of cuts through 2025, according to their median forecast. Bond traders, however, still expect a more aggressive pace.
“We have a longer and more predictable easing cycle coming,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “It will now be a battle between market expectations and the Fed, with employment data — not inflation data — determining which side is right.”
–With assistance from Vildana Hajric, Liz Capo McCormick, Emily Graffeo, Aline Oyamada, and Cecile Gutscher.
(Prices are updated in the fifth paragraph and changes to the bank forecast are added in the eighth paragraph)
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