How would the market interpret a Fed rate cut?
The last time the Fed embarked on a reduction of its fed funds target rate was in September 2007. The time prior to that was in January 2001. Both instances coincided with the beginning of large declines in the stock market.
Coming out of the Fed’s June meeting, it is now widely expected that the Fed will cut its rate target before the end of 2019. Investors might reasonably ask whether or not this potential rate cut should be viewed as similar to the cuts in 2001 and 2007.
In both of those cases, the Fed cut its rate in response to deteriorating financial conditions. In 2001, the equity market tech bubble was bursting; in 2007 the housing bubble was bursting and its effects were spilling over into the equity market.
In the post-crisis environment, the direction of the financial markets has hinged largely on the stance of Fed policy. Prior to the financial crisis, the release of data that pointed to a healthy economy was generally viewed as good news by investors.
In the wake of the crisis, however, such data has generally been treated as bad news, for fear of its implications for tighter Fed policy. So long as the Fed has been easing, or at the very least not tightening, investors have generally been happy, even in the face of subpar economic data.
Today, though some indicators point to a general slowing, the economy does not yet show signs of an imminent recession. If the Fed cuts its rate this year, it seems more likely to be out of a recognition that it increased the rate a little too far, a little too fast, a message the bond market has been sending loud and clear for a few months now.
Assuming that the “bad economic news = good policy news” paradigm still holds, and that the economy’s relatively good health is not merely optical, the market seems likely to respond positively to any cut(s) the Fed might make.
Unless otherwise noted, data is sourced from Bloomberg.
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