Extreme market volatility this week made Wall Street want the Federal Reserve to lower interest rates even more. This made people fear that the market could spread problems and cause a slump.
As the dust has settled, a new worry has come to the surface: investors who are waiting for the Federal Reserve to cut interest rates could be setting the markets up for another trap.
“I don’t think they want to be known as the “hot gun.” Janet Jaffee, a senior portfolio manager at TCW, told MarketWatch on Thursday, “That’s not what the Fed wants to do.”
Early this week, Wall Street was thinking about the chance of a short-term rate cut before the Fed’s policy meeting on September 17th and 18th. It doesn’t look like such a big change is going to happen, according to Jaffee, because fewer Americans than expected applied for unemployment benefits last week.
People were nervous after last week’s weak jobs report for July and worried that the Fed has kept rates too high for too long, which could lead to a recession. The jobless claims report seemed to calm people down.
Jaffee believes that September is the most likely month for the Federal Reserve to begin lowering interest rates. She’s not ruling out a 50-basis-point cut, but TCW’s base case is still 25 basis points. She said, “They want to get it right.”
Rate-cut craze
The jobless rate hit a three-year high of 4.3% in July, setting off the Sahm rule, a way to measure a labor market recession. This has put investors on edge.
Then, on Monday, the famous Japanese yen USDJPY 0.00% “carry trade” ended all of a sudden. This shook up global stocks and left financial markets frozen.
Monday was the worst day for the S&P 500 index SPX 2.30% in about two years. This was because Treasury yields fell and investors rushed to find safe havens from the storm. The “fear gauge” for Wall Street, the Cboe Volatility Index VIX -14.58%, also went through the roof.
Since then, volatility has gone down and weekly stock losses have been getting smaller. On Wednesday, J.P. Morgan analysts said that the global carry trade was already three quarters ended.
Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management Co., told MarketWatch, “I think the job market is getting weaker.”
Schutte said, “I think you have a group of people who want to be positive and buy stocks.” In case the U.S. goes into a slump, investors should at least be ready for volatility and be okay with the risks they are taking.
Not a “magic elixir.”
The Dow Jones Industrial Average DJIA 1.76% and the S&P 500 both had smaller weekly losses on Thursday. They were down 0.8% and 0.6%, respectively. The Nasdaq Composite COMP 2.87%, on the other hand, was down 0.8% for the week.
Since the beginning of the year, the S&P 500 has been on a strong rise, which has kept it up 11.4% so far in 2024.
The CME FedWatch Tool shows that traders now think there is a nearly 60% chance that the Fed will cut rates by 50 basis points in September. This is up from less than 5% a month ago. In that case, the fed-funds rate would go down to between 4.75% and 5%.
While the policy rate has been near a 20-year high of 5.25% to 5.5% for more than a year, the Fed has not yet caused a recession. Researchers at Société Générale say that short-term rates also show that rate cuts like those during a slump have already been fully priced in.
Not long ago, short-term rates started to show that more than 1% of rate cuts were already priced in for the next six months. In a Thursday client note, Jitesh Kumar’s stock derivatives strategy team at SocGen said that even though they were not as bad as they were on Monday, they were still “well in the recession category.” In the past, a 1% drop in GDP was needed for a recession to happen.
Kumar says that traders “aren’t waiting around to find out” if a recession is likely. He believes that Wall Street may have overestimated the number of rate cuts that would happen.
Kumar thinks that markets could go through another period of instability if economic data doesn’t match expectations for a slump.
The 10-year Treasury yield TMUBMUSD10Y 3.997% quickly shot back up to 5%, a 16-year high, when the bond market became very volatile in October. At the same time, stocks went into a correction.
Schutte at Northwestern Mutual said, “Everyone thinks that lowering interest rates will cure everything.” He did say, though, that the Fed has cut interest rates before, when the economy was weak and during recessions. He said, “I tell people to think about the ‘what ifs.'” “Own parts of the market that no one else wants.”
