The stock market had difficulty Wednesday digesting the Federal Reserve’s reluctance to lower short-term rates by half a percentage point. The S&P 500 finished down 1.1% for the day when the Fed only reduced by a quarter-point.
But guess what? The Fed futures contracts now fully expect the central bank to lower its federal funds rate by another quarter-point at its September meeting. In fact, as of Thursday’s market close, the CME Group contracts overwhelmingly believe this will happen, by 81.9%. A mere 18.1% think the Fed will stand pat, at the newly struck target range of 2.0% to 2.25%.
Thursday morning, the stock market seemed to reconsider and the S&P 500 rallied 1%. That was before President Donald Trump imposed more tariffs on Chinese goods, which pulled stocks down again—and is unrelated to the Fed.
For what it’s worth, the new CME odds are 47.6% that the Fed will bring down rates by yet another quarter-point by year-end, for a total decrease this year of 0.75 point.
Right before the Fed’s action on Wednesday, the futures were almost evenly split between a quarter-point drop (49.3%) and half-point one (48.6%).
What does this all tell us? That the market gets freaked out by any notion that low rates won’t persist and won’t get lower still. Indeed, the stock market is addicted to low rates. For one thing, they ensure that borrowing costs will stay low, a boon for both consumers and businesses.
But even more important, low rates mean that investors will continue to prefer stocks because fixed income pays so little. Hence, the adage TINA: There Is No Alternative. Than stocks, that is.
Indeed, Fed Chairman Jerome Powell, at the press conference following the rate announcement, returned to his old refrain that any more easing awaits what the data reveals up ahead. His comments indicate there is no “signal that future rate cuts are highly likely,” wrote Ken Metheny, executive director of Macroeconomic Advisers, in a research note.
Yet Powell’s remarks don’t rule out more cuts either. The chairman did say that Wednesday’s move was not “the beginning of a long series of cuts.” Now, what does he mean by “long?” One or maybe two more don’t seem to fit under that rubric.