Michael Reinking:
Good morning. I'm Michael Reinking, Senior Market Strategist at the New York Stock Exchange, and you are listening to the Market Storylines podcast on the Inside the ICE House podcast feed. As always, I wanted to thank everyone for tuning in over the last few weeks. Now is recorded on Thursday afternoon. Let's get to this week's Market Storylines.
Last week, we spent some time previewing this week's Fed rate decision, where I discussed the potential rationale for a 50 basis point cut, but explained that since this hadn't been communicated to markets that I thought it was unlikely, as a surprise could create unwanted volatility in currency markets, potentially triggering another round of carry trade unwinds, which were at the epicenter of the August volatility. Well, a couple of hours after we recorded, the most consequential piece of news hit the tape, as The Wall Street Journal's Nick Timiraos broke a story quoting multiple former Fed officials who weighed in on that 25 or 50 basis point debate. This included a quote from Jon Faust, the former special advisor to Chair Powell up until earlier this year, that he would lean to 50 basis points.
Now, these quotes don't just happen out of thin air, and they are deliberate, with officials clearly understanding the ramifications. But this wasn't just any story, it came from Nick Timiraos, who earned the nickname the Fed whisperer after his story in June of 2022 during the Fed's media blackout window, where he suggested that the committee was considering a 75 basis point hike, out of line with current market expectations, in response to the inflation data. He also happened to write the book, Trillion Dollar Triage, a good read about the inner workings of the Fed during the pandemic, so he's clearly well-sourced.
The trial balloon addressed one of my major concerns, as it gave markets time to adjust and gave officials a look at the market reaction. It even helped control the message around a 50 basis point cut being done to move rates off an overly restricted level, given the progress on inflation as opposed to there being some ominous economic event on the horizon. Now, the initial market reaction was reasonably muted with the US dollar index pulling back, the Yen strengthening, while yields move lower and equities extended the week's gains. But like Ray Kinsella, the main character in the Field of Dreams ...
Audio:
If you build it, they will come.
Michael Reinking:
... I couldn't get the voice of the whisperer out of my head. And on Friday morning in our note, I wrote that, at the very least, I thought that the probability should be skewed to 50 basis points at that point.
Well, the debate continued and got louder throughout this week without much pushback, even after a retail sales report that came in slightly better than expectations. Now, the odds did eventually shift in favor of that larger cut, but it wasn't a slam dunk, and it was essentially a coin flip heading into the 2:00 decision.
Well, Chair Powell delivered with a 50 basis point cut, though there was the first dissension by a governor since 2005, with Michelle Bowman preferring a 25 basis point cut. The message delivered by the committee was not unabashedly dovish, with the projections for rates by the committee in the so-called dot plot pointing to an additional 50 basis points of cuts this year, and an additional 100 basis points of cuts by the end of next year, leaving rates just under 3.5%, which was higher than market expectations coming in that were priced just under 3%, which has happened to be in line with the Fed's previous projection for its neutral rate.
Now, Chair Powell controlled the message in his press conference, saying that this was a recalibration of policy back to neutral over time, as the balance of risks had shifted and were more in balance now, favoring a response to ensure the labor market remained resilient. Throughout the press conference, he tamped down concerns that this was about a weakening in the economy, calling the cut a risk management tool. And when asked by the whisperer himself if the larger cut was a catch-up in response to recent revisions to labor market data, the chair gave his strongest answer, saying, "We don't think we're behind, but I think you can take this as a sign of our commitment not to get behind." He also went out of his way to temper market expectations for further outsize cuts, saying that the path forward would be data-dependent and that the committee was in no rush, while also suggesting the neutral rate was likely higher than pre-pandemic levels.
There was a mixed response within equity markets on Wednesday, which after briefly touching a new all-time high closed modestly lower on the day. But I think the reaction in bond markets was telling, in that rates and the US dollar both moved a bit higher. Coming in, you could make the argument that the bond market was questioning the soft landing narrative, pricing in an aggressive easing cycle. It seems that the mix of the aggressive action to get in front of the weakness and the chair's messaging acquiesced some of those fears, at least for the time being.
Now, investors had the opportunity to digest this information overnight, and we are seeing a risk-on response here on Thursday. We had global equity markets moving sharply higher, commodities have rallied, and even cryptocurrencies are moving to fresh highs. In the US, the S&P 500 is up a little over 1.5%, hitting a new all-time high, trading just over 5,700. Now, breakouts can be tricky, and going forward, we'll want to see some commitment to the strength in the coming days, but the timing is also very interesting, as the final two weeks of September is historically the worst two-week window within the year for the market. It does feel like the pain trade from here is higher, given there has been money that has moved to the sidelines in expectation for further volatility heading into the election.
There are still a couple of catalysts ahead of us before the week is over. On Friday, the Bank of Japan has its rate decision and is expected to remain on hold, but markets will pay close attention to the messaging about further rate increases. In the US on Friday, it is also triple witch expiration, where stock options, index futures, and index options all expire on the same day. Friday is also the S&P quarterly index rebalance. This day is a very big liquidity event, with the closing auction on the New York Stock Exchange routinely exceeding 1 billion shares, one of the heaviest volume days of the year.
Now, next week we'll be a little bit quieter with a couple more central bank rate decisions, but the majors are out of the way. The key economic data will include global flash PMIs, and then personal income and spending in PCE, the Fed's preferred gauge to inflation, at the end of the week, though the latter has largely been de-risked, given the PPI and CPI report we got last week. But we remain on the treadmill of economic data, with the labor market data right around the corner again. In terms of corporate announcements, we're a couple of weeks away from the start of earnings season, but be on the lookout for pre-announcements leading in.
Thank you very much for spending some time with us today. Remember to tune in every Friday for the Market Storylines podcast on the Inside the ICE House podcast feed, and rate, review, and subscribe wherever you get your podcasts. I thank you for listening. I'm Michael Reinking. I'll talk to you again next week.
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