The Federal Reserve gave investors exactly what they said They wanted to cut interest rates by a whopping 50 basis points on Wednesday – but that was still not enough. After a brief rise after the initial announcement, stock prices went through a period of high volatility before all three major US market indices closed in the red on Wednesday.
The Dow Jones Industrial Average fell 0.25%, while the S&P 500 and tech-heavy Nasdaq Composite fell 0.29% and 0.31%, respectively.
Markets sold off even though Fed Chairman Jerome Powell told reporters at his post-FOMC press conference that the 50 basis point rate cut was intended to demonstrate central bankers’ “confidence” that the current strength of the labor market can be sustained with an “appropriate rebalancing” of monetary policy.
While no one can know the definitive reason for the equity markets’ negative reaction to the huge rate cut that was supposed to boost the market, Rick Rieder, CIO of Global Fixed Income at BlackRock and head of the BlackRock Global Allocation Investment Team, offers a theory.
Looking at the Fed’s summary of economic forecasts, Rieder noted that Fed officials have planned two more rate cuts of 25 basis points each this year and another 100 basis point cuts in 2025. While that’s a lot, it’s not what investors had priced in before the meeting.
“The market has priced in a path for interest rates that is more similar to what a looming recession would require … as opposed to a recalibration of rates toward a less restrictive or neutral policy trajectory, which we believe this cycle is likely to represent,” he said. Assets by email.
Although markets received a hefty 50 basis point rate cut in the short term, Fed officials’ longer-term interest rate outlook was essentially not as attractive as expected.
Thomas Simons, a senior economist at investment bank Jefferies, echoed that view in a note to clients on Wednesday. “The long-term interest rate continues to be revised upward, implying a higher terminal rate. Today’s 50 (basis point) cut was a modest surprise, but we see no signs that further large cuts are imminent,” he said.
The economy is doing well and we are not lagging behind
There is another possible reason for the negative reaction of the stock markets to the Fed’s decision on Wednesday. Some see the Fed’s disproportionate rate cut as a sign that they have realized that they should have started cutting interest rates months ago.
Powell addressed those concerns in his press conference on Wednesday. “We don’t think we’re behind… You can see this as a sign of our determination not to fall behind,” he told reporters.
But quite a few experts simply do not believe that. “The Fed believes it is lagging behind,” said Robert Minter, director of ETF investment strategy at abrdn, Assets by email.
The skepticism is not unfounded. Even Powell himself admitted that Fed officials would likely have cut rates had they seen the weak July jobs report before the FOMC meeting this month. “Had we gotten the July (jobs) report before the meeting, would we have cut? That could have been the case,” he said. “We did not make that decision. But you know we could have.”
Robert Frick, corporate economist at Navy Federal Credit Union, even argued that the Fed may be concerned that labor market data is not as reliable as previously thought after revisions to previous labor market data showed that the U.S. economy employed 818,000 fewer people between March 2023 and March 2024 than originally reported.
“The half-point cut is an admission that the Fed is lagging behind, but not a sign of panic,” Frick said. Assets by email. “The Fed has been ‘data-driven,’ but doubts about those data have proven to be justified, as they did not paint an accurate picture of the labor market.”
“With inflation virtually at rock bottom, the Fed must quickly improve hiring conditions and stimulate investment to create more jobs,” he added.
However, during his press conference, Powell again attempted to address concerns about the labor market and economic weakness.
“The U.S. economy is in good shape,” he said. “It’s growing at a solid pace. Inflation is low. The labor market is strong. We want to keep it that way. And that’s exactly what we’re doing.”
“I don’t see anything in the economy right now that suggests the likelihood of a recession – sorry, a downturn – is increased,” he added.
Some experts also welcomed Powell’s decision to cut interest rates by 50 basis points. “For the first time since the pandemic, this Fed has taken aggressive action to get ahead of the curve by cutting rates to ensure the economy does not slide into recession,” said Jay Hatfield, CEO of Infrastructure Capital Advisors. Assets by email.
Perhaps it was these disagreements between various experts that led to Wednesday’s volatile trading activity. Steven Wieting, interim chief investment officer at Citi Wealth, warned that this could happen even before the Fed’s announcement, noting that volatility is normal as investors process the Fed’s decisions and their myriad potential implications.
There was another potentially market-dampening comment from Powell on Wednesday.
As for the future outlook for the neutral interest rate – the level at which monetary policy is neither stimulative nor accommodative – Powell said he believes we will not return to the near-zero interest rates that were common before the pandemic.
“My impression is that the neutral interest rate is probably significantly higher than it was then,” he said.
With many investors looking for clues about where interest rates will go, not just in the near future but also over the next few years, this comment could have exacerbated the equity sell-off.
