Look who’s back?
As we outlined in our quick-take on Thursday, Chairman Powell was ‘confidently dovish’ in the latest FOMC, and acted aggressively with a 50bp front-loaded cut while still advocating an economic soft-landing. The result was clear — a significant dovish impulse to celebrate the official start of a new Fed easing cycle, with risk markets taking ~12 hours to digest the message before driving equities to new all-time highs. What happened to the recession?
Fixed income was once again the ‘adults in the room’, with yields relatively well-behaved, but with a structural curve steepening bias starting to take place. 2y — 5y yields stayed towards its YTD lows following the aggressive Fed move, while 10y — 30y yields stayed bid against improving risk sentiment and insurance against a return of inflation, with core PCE due this Friday. While others might disagree, we believe that a 50bp cut at this juncture is ‘unconventional’ based on economic fundamentals alone (Atlanta Fed GDP still tracking ~3%, labour market still holding up, inflation still above 2%), so the Fed’s action should be seen as an explicitly dovish signal that markets are right to respect in the near-term.
So what could derail the rally? Ultimately, it comes back to hard data, which the Fed themselves have been alluding to. The keys will remain with 1) the degree of slowing in the US labour market and 2) the continued pace of CPI easing, both of which are currently still working in the Fed’s favour, and the burden of proof will be on the economy to ‘prove’ the market wrong. In other words, the rally will ‘remain innocent until proven guilty’, at least until the economy shows a critical slowdown that is deemed beyond rescue by the Fed easing.
For US equities, aggressive rate cuts into a soft-landing with no obvious downside catalysts can only mean it’s smooth sailing to new all time highs again, which is exactly what happened last week. Equities have managed to handle negative September seasonals exceptionally well, and even Trump’s fading polls have done little to discourage the risk-on rally with high-beta sectors such as AI-stocks looking to re-accelerate again. Similar to the story in bonds, economic data reigns supreme, with investors likely to be remain better buyers-on-dips heading into the final month before elections. Finally, technical measures look positive for the SPX, with strong momentum breaks to the upside which bears watching in the near-term.
Over in crypto, prices have staged a decent recovery with BTC rallying 6% on the week as the correlation with equities (and gold) has returned to 2-year highs. The infamous chart of BTC vs 3x-levered Nasdaq has re-converged after a brief period of outperformance, though it does feel like that crypto is poised for a sharper short-term move with alt-coins trading particularly strong last week. Even the much-maligned Ethereum has managed to gain 11% over the past week on no particularly new developments. We believe that this rally could have legs with the Fed’s ‘dovish pivot’ finally seen as consensus.
The particular strength of the altcoin rally is an encouraging sign, and might be suggestive of a more impulsive rally in the near-term, as long as equity sentiment holds up. BTC spot inflows have resumed somewhat in the past week, and might be on pace to make new cumulative highs before the month is over. Will a continued price rally rescue ETH ETF inflows from its current doldrums? We believe the answer will depend on whether we can get another blow-off top in equity before November, and we are already benefitting from the Fed’s dovish turn.
Another positive for ETF inflows might come from the SEC’s approval of new ETF options listing. As we have been advocating for a long time, options are a dominant asset class in TradFi and are favored by many institutional players, so it was only a matter of time before they entered crypto and grow in prominence going forward.
Speaking of the importance of options, TradFi will see over $4.3 trillion in option expiries this week for US equities, with particular activity out of index options as everyone is an index vol trader now (similar to the rising BTC dominance). Will investors roll out of their expired positions into more upside calls after month-end? Time for some OTM Calls on BTC into year-end? Let’s make sure to keep an eye out on this space!
Looking ahead, the market will focus on a busy docket of Fed speakers who are exiting their communication blackout periods post FOMC. We’ll have 3 Fed speakers on Monday, 6 on Thursday (including Powell), and 2 more on Friday to end the week. Particular focus will be on Powell’s comments on Thursday as markets will gauge his reaction to the substantial easing in financial conditions, while the only major US data of note will be Fridays’ PCE.
Overall, macro markets are likely to continue on a slow melt-up this week as a base case, with option markets pricing in little risk premium until NFP on October 4th. We do not expect Fed members to ‘rock the boat’ with their upcoming speeches, and the path of least resistance is likely to be up until further notice.
Good luck to our readers and be careful with fighting the Fed!
