Are Traders Misjudging How Markets Will Respond to Today's Rate Cut?
Market Expectations
As the 2pm Fed announcement approaches, the market seems to be divided into two camps. One group believes that a 25bps cut will negatively impact risk assets, given that a 50bps rate cut has already been factored into prices. The other group thinks that a 50bps cut would be beneficial, leading to a surge in risk assets like stocks, bonds, gold, and commodities.
Contrarian View
However, Brian Garrett, one of Goldman's top derivatives traders, challenges this conventional wisdom. He suggests that the market's initial reaction may not be sustained throughout the day. If the Fed cuts by 50bps, he expects a brief rally, followed by a flattening or slight drop. If the cut is 25bps, he predicts an initial sell-off, which will eventually be bought up.
ETFs and Sectors Performance
Garrett also provides data on how ETFs and sectors have performed on the day of the initial cut. He recommends looking at the movements in gold proxies for non-recessionary cuts, such as GDX and GDXJ, which have shown increases of 4.8% and 5.6% respectively.
Equities and Bonds Performance
In terms of how equities and bonds perform after the start of a cutting cycle, Garrett notes that if there is no recession, stocks tend to rise and the dollar strengthens, and vice versa.
Mark Cudmore's View
Mark Cudmore, a former Lehman trader and current Bloomberg commentator, echoes Garrett's sentiments. He warns traders to expect a counterintuitive response to the Fed's actions. If the Fed cuts rates by 50bps, he believes it will extend the economic cycle and send a message of complacency on inflation. This could lead to a rise in US 10-year yields in the following months, and a volatile downtrend in the dollar.
Impact of 25bps Cut
On the other hand, if the Fed cuts by 25bps, Cudmore predicts a major risk-aversion event. This could disappoint all major markets at once while upsetting the recent trend for dollar weakness. However, if this smaller-than-expected cut is accompanied by dovish forecasts, then dollar strength may not last long.
The Importance of the Fed's Dot Plot
Cudmore also highlights the importance of the Fed's dot plot. A 50bps rate cut combined with a hawkish press conference could be worse for stocks than a 25bps cut accompanied by a dovish press conference.
Buying the Dip
In conclusion, if the Fed cuts by 25bps and stocks drop in a kneejerk reaction, buying the dip could be a good strategy.
Bottom Line
This article provides a contrarian view on how the market may react to the Fed's rate cut announcement. It suggests that traders may be misjudging the market's response. It also highlights the importance of the Fed's dot plot in shaping market reactions. What are your thoughts on these predictions? Do you agree or disagree? Share this article with your friends and let us know your views. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.
