Wall Street is betting that Federal Reserve Chairman Jerome Powell will confirm a rate cut at the central bank’s annual meeting in Jackson Hole, Wyoming. But as the debate shifts from “will there be a rate cut” to “how much will it be,” stock traders may not be able to meet expectations.
“If traders hear that a rate cut is coming, the stock market will react favorably,” said Eric Beiley, executive managing director of wealth management at Steward Partners Global Advisory. “If we don’t hear what we want, that’s going to cause a sell-off.”
That’s the challenge facing money managers who have just piled back into big tech stocks chasing the S&P 500’s climb higher. The market fully expects the Fed to start cutting rates at its upcoming September meeting. But Powell could easily have remained tight-lipped about the timing of a rate cut when he speaks on Friday. And it’s very much in his character to take a cautious, noncommittal approach when it comes to revealing how much the Fed might cut rates.
“The market is confident that a rate cut is coming,” Bailey said. “It would be a huge surprise if Powell didn’t reinforce that.”
The surprise threatens to derail the S&P 500’s $3.3 trillion rally after global growth fears triggered the year’s worst sell-off in early August. Investors poured $5.5 billion into U.S. stocks in the week ended last Wednesday, as the benchmark index gained seven straight sessions, according to Bank of America Corp. citing data from EPFR Global.
S&P 500 market value grows by more than $3 trillion since August low
But some Wall Street professionals warned investors not to have too high expectations for the Fed chairman's speech.
“Based on past speeches at Jackson Hole, Powell is unlikely to deliver a very prescriptive speech,” said Tom Hainlin, national investment strategist at U.S. Bank Wealth Management.
Bill Dudley, a Bloomberg Opinion columnist and former New York Fed President, believes Powell may signal that tight monetary policy is no longer necessary, but he does not expect Powell to signal the size of the first rate cut, especially because officials will also have to consider the Sept. 6 jobs report before making the next policy decision on Sept. 18.
“His tone is critical,” said Stephanie Lang, chief investment officer at Homrich Berg. “If he shakes up the market and comes off as hawkish, the stock market will react negatively.”
To be clear, traders fully expect the Fed to cut rates at its next meeting, but they are unsure how much. With a small slate of officials scheduled to speak in the coming days, Powell's speech carries a lot of weight. Based on the cost of at-the-money puts and calls, options traders are pricing in a 1% move in the S&P 500 on Friday, either up or down, according to Citigroup.
Still, Wall Street is praying that the pain of this summer is over, with the S&P 500 2% away from an all-time high. Open interest in options betting on a fall in the Cboe Volatility Index, compared with contracts betting on a rise, hovered near the highest level since June 2022, data compiled by Bloomberg show.
Rate cuts have historically been used to stem slowing economic growth, and as there are signs that the current U.S. economy is resilient, traders have reduced bets on a big rate cut in September, with a rate cut of about 30 basis points currently priced in. Bank of America's Heinlein believes this means that market risks from the Jackson Hole meeting are fading and investors are no longer expecting aggressive rate cuts.
"We want to know what the Fed's rate path is, whether it will be one cut per meeting or whether it will still depend on employment and inflation data," Heinlein said. "But he probably won't say that. Traders are more likely to get that information at the Fed's September meeting."
The Fed chairman’s speech at Jackson Hole doesn’t typically have a big catalyst for the stock market unless it precedes a key shift in monetary policy — like now. Since 2000, the S&P 500 has risen an average of 0.4% in the week following the meeting, according to data compiled by Bloomberg Intelligence.
S&P 500 historical performance after Jackson Hole central bank meetings
Traders were still fresh in their minds about Powell's August 2022 speech at Jackson Hole, when he warned that the Fed needed to keep monetary policy restrictive to fight inflation. Stocks plunged 3.4% that day and fell another 3.3% in the week following his speech. This time, however, investors were hoping that the Fed had achieved its goal of a soft landing, which is to keep prices from spiraling out of control without causing severe economic pain. So the expectation was the exact opposite, a big rally.
With three FOMC policy-setting meetings left in 2024, traders are betting the Fed will respond to signs of weak employment with rate cuts as inflation retreats toward its 2% target. The underlying consumer price index fell for a fourth straight month in July, while strong retail sales data suggested Americans’ spending remains strong, allowing officials to pursue less aggressive policies.
“Powell doesn’t need to scare the market,” said Homrich Berg’s Lan. “He needs to convince the market that inflation is receding and officials can feel comfortable lowering restrictive interest rates to a more neutral level.”
The article is forwarded from: Jinshi Data