Fed Recap:

This was the most anticipated and heavily debated rate decision in recent memory, and it lived up to the hype. Insert Michal Buffer voice here, “And still undefeated, undisputed Whisperer of the World the WSJ’s Nick Timiraos”. After last week’s inflation data markets seemed comfortable in the prospect of a 25bps cut, that is until a mid-afternoon article last Thursday from the Mr. Tmiraos, the Fed Whisperer, who officially earned that moniker by suggesting that the Fed would consider a 75bps hike back in June of 2022, also during the media blackout window, when the market was pricing in a smaller cut.

To set the stage for those just joining us, this article quoted multiple from former Fed officials weighing in on the 25/50bps debate. This included a quote from Jon Faust, the former special adviser to Chair Powell up until earlier this year, that he would lean 50bps. These quotes don’t happen by accident and former officials full well understand the potential impact on markets. Prior to that article I was solidly in the 25bps camp but like Ray Kinsela, the main character in the Field of Dreams, I couldn’t ignore the Whisperer given his track record.

Part of the reason I had thought Committee would move 25bps was that it typically likes to move methodically with clear messaging to the market. Floating this trial balloon addressed that final point. One of the risks to not messaging a larger cut in advance was that this would have caused volatility in currency markets, which if you rewound the clock to the begin of August, was at the epicenter of the volatility with the unwind of carry trades. Putting this out to the market allowed the Fed to see that play out in advance and markets begin to reposition. In addition, it allowed them to control the message, that the cut would be to address rates that were overly restrictive in their view given the progress on inflation as opposed to an ominous economic event on the horizon. Addressing these two concerns made the prospect of a 50bps very real and there was very little pushback in that message since. Interestingly enough, there were multiple very recent departures from the Fed including Bullard, Mester, and Clarida who came out toady all saying they thought the Committee would opt for 25bps. Coming into 2:00 probabilities were essentially a coin flip.

As you’ve already surmised, the Fed opted to cut rates by 50bps taking the Fed Funds Target rate to 4.75% - 5%.  The first paragraph of the statement was revamped pointing out a slowdown in the jobs market and inflation that had made progress to the Committee’s 2% target. The rest of the statement was tweaked to suggest the balance of risks between inflation and employment were now more in balance. In addition, we saw our first dissent since 2005 as Michelle Bowman preferred a 25bps cut. 

The focus quickly shifted to the updated Summary of Economic Projections. 2024 GDP was reduced to 2.1% from 2%, which given where things are currently tracking is a negative read. However, estimates out through 2026 were left unchanged at 2%. The estimate for the Unemployment rate moved up to 4.4% which is 0.2% above the current level, while 2025 and 2026 estimates were revised up 0.2% to 4.4% and 4.3%, respectively. Core PCE was lowered to 2.6% this year and 2.2% next, hitting their target in 2026. 

Which brings us to the DOTS which is where you can start to see the varying views on the Committee more clearly. The median projection for 2024 was 4.4% pointing to 2 additional 25bps cuts. However, there were 2 officials (we know Bowman and the other is probably Barkin) seeing no additional cuts while 7 more see only 1 more. In 2025, the median projection was for an additional 100bps of cuts to 4.4% but the range of estimates is wide at 2.9% - 4.1%. This was not as aggressive as markets were looking for coming in as futures were pricing under 3%, but I think the market took some comfort in the fact that 8 of the 19 officials were below 3.25%. Officials see rates back to neutral in 2026 at 2.9% with the longer run estimate also ticking higher again. 

The initial response to the statement was a modest rally in equities with the S&P 500 probing its all-time high again and outperformance in small caps. The initial move in yields was to the downside while the USD traded lower to test the $100 level.

Chair Powell took to center stage. He highlighted the shift in the Fed’s focus within its dual mandate, a continued evolution from the last meeting suggesting the risk going forward resided within the labor market. He described the labor market as cooling from an overheated state but highlighted that the policy steps taken were to help maintain that overall strength. When the Whisperer asked if this was a catchup in response to the labor market data the Chair said, “We don’t think we’re behind. You can take this as a sign of our commitment not to get behind.” However, he did later suggest that if the Fed had the July employment report that it might have cut then.

Throughout the press conference he tried to temper expectations for additional larger cuts going forward saying that the Committee is in no rush, pointing to the SEP and his view that the neutral rate was higher than pre-pandemic (suggesting the ultimate destination may not be as deep as their current Long Run rate). He described the easing as a recalibration, a word he used repeatedly, given the progress on inflation as opposed to being a response to economic weakness. These were the main messages he reiterated throughout Q&A continuously pointing to resilience in the economy and the labor market and describing the actions as a risk management tool with further policy adjustments being data dependent. One of the most awkward moments of the press conference was when asked about the lack of messaging heading into the Blackout Window and whether the Fed would have moved 50bps if the market pricing hadn’t adjusted in advance, and how much that played into the calculus. In his shortest answer of the day, he just said we’re just going do the right thing for the economy and that’s what we did. It clearly was something officials were thinking about otherwise the press wouldn’t have gotten the quotes that they did.

The discussion about QT was limited with no suggestion that the Fed is considering ending the pace in the near term with the Chair saying reserves are abundant and expected to remain that way while pointing to the drainage of the RRP.

Despite the larger cut the message today was not unabashedly dovish which was not necessarily a bad thing. Fixed income markets were pricing in a very aggressive rate cutting cycle with the widespread between the 2yr yield and the Fed Funds target (see Chart) suggesting some skepticism with the soft-landing narrative. The aggressive action taken today seems to have acquiesced some of those concerns by pulling forward those cuts potentially leading to a less deep cutting cycle. As such yields did move a bit higher today especially at the long end.

It was a choppy session for equity markets with major indices giving up the initial rally to end the day mixed slightly lower than where they were prior to the meeting.  There was some underperformance in yield-oriented, defensive sectors and info tech. 

Below I've updated some of the charts looking at the S&P 500 and Russell 2k leading into and following the first cut.

The S&P 500 is hovering just under its all-time high and is struggling with the underside of the previously broken trendline off the October low. The market made another marginal new all-time high today before fading leaving a bit of a topping tail which could lead to some additional downside.  Breakouts to fresh all-time highs can be particularly tricky.

On the downside traders defended 5,600 last week after the initial rally that is the first level to watch tomorrow. The two bigger levels are the 50d (~5,515) and then the recent lows/100dma (~5,400). If those levels break that would open the door to a pullback to retest the August lows and 200d ma between 5,150 - 5,200. Keep in mind it is options expiration so the breaking of strikes could quickly add to momentum.

If there is a breakout attempt we will want to see it happen with authority and hold with some commitment to the strength in the coming days. There is a very loosely formed inverse head and shoulders pattern which if we can break through the highs would project a move in the medium term to ~6,100. 

The NYSE FANG+ index is trying to break the downtrend from its July high. How this group of stocks react will drive the S&P. Watching the recent highs in this index around 11.5k to break this downtrend and put the previous highs back in play. 

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