FOMC Preview: Can the Fed Still Surprise the Markets?
FOMC Preview: Can the Fed Still Surprise the Markets?
By:Ilya Spivak
The markets won’t be happy if the Fed struggles to embrace lofty rate cut expectations.
- Stocks, bonds, gold prices, and the US dollar are geared up for Fed rate cuts
- With this month’s move already priced in, new FOMC forecasts are in focus
- Wall Street may be in trouble if Powell and company leave markets wanting
Financial markets seem clearly positioned for a rate cut from the Federal Reserve. So far this week, US stocks are up while Treasury bond rates are lower across the yield curve, and the US dollar is down against major currencies while gold prices continue to climb.
The bellwether S&P 500 index and the tech-tilted Nasdaq 100 touched record highs on the eve of the incoming policy announcement from the US central bank’s rate-setting Federal Open Market Committee (FOMC). So too did gold. The greenback has slid to levels unseen since early July, where it marked a three-year low before a shallow rebound.
Financial markets are all the way geared up for a Fed rate cut
Fed funds interest rate futures imply the markets have seen a rate cut at this weeks meeting as a certainty for nearly two weeks. The likelihood of a standard 25-basis-point (bps) cut has risen to 96.1% from 93% a week ago, while the likelihood of an outsized 50bps move has declined to 3.9% from 7.03%.
With traders so firmly locked into expectations – and barring a shockingly large cut or an unexpected hold – the rate move itself seems unlikely to impact the markets one way or another. That puts the spotlight on the lingering disparity between traders and central bank officials about what will happen after this month.
Markets are priced for 70bps in cuts next year. That amounts to at least two 25bps reductions and a commanding 80% probability of a third one. For its part, the Fed projected a single cut when officials last updated quarterly forecasts in June. Traders are likely to be disappointed unless the FOMC takes a step to close this gap with a dovish rethink.
Stocks are at risk if new FOMC forecasts leave traders wanting
Minutes from July’s policy meeting show a majority of officials see “upside risk to inflation [is] the greater concern compared to downside risk to employment.” Speaking at the Jackson Hole symposium last month, Fed Chair Powell committed to act forcefully to ensure inflation expectations remain well-anchored.
Nevertheless, Powell argued that a shifting balance of risks “may warrant” adjusting policy, and flagged downside risks to the labor market. Traders saw that as the go-ahead to cut this month. This hinges on Powell’s bet that higher inflation from tariffs will be short-lived, implying this will be overpowered by the damage that they do to economic growth.
In the meantime, the closely watched GDPNow tracker from the Atlanta Fed hints the economy is on track to accelerate in the third quarter. As much appears in leading PMI surveys from S&P Global and the Institute of Supply Management (ISM). At the same time, inflation has hit a 7-month high, with goods prices growing at the fastest in 2 years.
Powell and company may not be ready to credibly commit to an expansive easing cycle against such a backdrop, at least for now. Stocks may turn lower alongside gold prices while the US dollar may stage a recovery if their forward guidance leaves the markets wanting.
Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak
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