Display an der Wall Street zeigt Fed-Chef Powell. Foto: Bloomberg
The past trading week is another example of Wall Street’s current limitless appetite for risk. It was only a week ago that the US stock markets ended a very weak trading week. The US benchmark index S&P 500 lost 4.3% on a weekly basis as there were great concerns that the Fed was already behind the curve and that the downturn in the US economy was gathering pace. This week the index rose again by 4% due to a large bet on the Fed and a soft landing, although nothing fundamental has changed. The economy continues to send warning signals and there is great uncertainty about how much the Federal Reserve will cut interest rates. The stock markets seem to be almost indifferent whether the Fed announces a large or small interest rate cut; they just want to have a big bull party.
Stock markets: Big bet on the Fed
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Wall Street’s risk-taking brigade has consistently turned a deaf ear to the Federal Reserve’s political machinations and the changing economic sentiment in the bond market. Now — with markets firmly anticipating a Fed rate cut in the coming days — traders are paying attention and initiating a new round of bets on a soft landing, according to a report from Bloomberg.
Sentiment in tech stocks, cryptocurrencies and junk bonds flared up again this week as market participants were encouraged by a rise in expectations that the US Federal Reserve may make a rare half-percentage point rate cut. The FedWatch tool, meanwhile, shows a 50/50-Chance for a jumbo rate cut. The turnaround was particularly pronounced in the Nasdaq 100, which rose by almost 6% for five consecutive days after falling by a similar amount the previous week.
It’s the latest twist in what has been a particularly fertile period for market stories of late. After nearly succumbing to a vision of economic gloom, stock traders have convinced themselves that growth is sustainable, especially as a widely anticipated monetary easing approaches. But the question remains: Why would the Fed cut rates aggressively and sharply when the economy is doing so well and inflation has not yet been defeated?
Stock markets believe in Goldilocks scenario
One group of bulls even sees an ideal investment backdrop: a proactive US Federal Reserve – possibly thanks to extra-large interest rate cuts – is stimulating a still expanding economy.
“The best-case scenario for equity markets: good economy, lower interest rates, declining inflation,” says Priya Misra, portfolio manager at JPMorgan Asset Management. “A 50 basis point rate cut is good news. It shows that the Fed does not want to fall behind the curve.”
Big minus, big plus | Nasdaq 100 records biggest weekly turnaround since 2022
Futures markets resumed betting on a big rate cut on Friday, just days after giving the prospect virtually no chance. The postponement extended a brisk rally in stocks seen as beneficiaries – cheap stocks, smaller companies and those that pay high dividends – while depressing the dollar.
The S&P 500 posted its best week since November, gaining 4% in five sessions, and is now just 50 points away from its all-time high reached in July. Junk bonds also climbed and cryptocurrencies gained.
Nevertheless, the price of gold hit an all-time high this week, while 10-year Treasury yields hit a 15-month low – both market moves that can be interpreted as negative economic signals.
Expectations for Fed rate cut in September fluctuate widely | Bets on 50 basis points grow rapidly
Aggressive Fed easing
The above-forecast figures Core consumer prices and the relatively robust labor market suggest that the Fed will cut interest rates more moderately in the future. Nevertheless, economists such as former New York Fed President William Dudley and JPMorgan’s Michael Feroli believe that the Fed should cut interest rates more to avoid falling behind the curve.
“In our view, it is clear what the Fed should do next week: cut interest rates by 50 basis points to reflect the changing risk balance,” Feroli wrote in a note on Friday.
According to Raphael Thuin, head of capital markets strategies at Tikehau Capital, the Fed is walking a fine line.
“A 50 basis point rate cut by the Fed aimed at a weakening economy could unsettle equity markets and potentially trigger volatility as we approach year-end,” he said. “On the other hand, if a 50 basis point cut comes in response to favorable inflation data and is accompanied by a reassuring message from central bankers, it could provide a boost to risk assets.”
Skepticism about the bull party
Whatever the Fed does, the venerable Doug Ramsey is skeptical that the party that bulls in the stock market are preparing for will last long. The Leuthold Group’s chief investment officer believes that the unique characteristics of the current rally in risky assets suggest that it is likely to have a short lifespan.
Of the last 12 bull markets, only four originated outside of a recession – and these lasted on average only half as long as the others, Leuthold’s data shows.
“Bull markets that lack the traditional recessionary ‘father figure’ tend to have shorter lifespans and deliver significantly fewer gains for the S&P 500,” he wrote in a note. “If the current bull market were to match the average performance of its four most cyclically relevant predecessors, it would extend to May 2025, with the S&P 500’s rise ending at 5,852 — about 4% above the Sept. 13 close. Not good.”
The caution is also reflected in hedge funds, which have reduced their net exposure to equities to the lowest level since late last year, according to Morgan Stanley’s prime brokerage team. More generally, market positioning is becoming more cautious, and US equity funds have seen their biggest weekly outflows since April, Bank of America’s EPFR Global data show.
Stock markets: Interest rate expectations too high
Skeptics also point out that the pace of rate cuts priced in Fed fund futures – more than two full percentage points over the next 12 months – without triggering a recession has rarely been seen.
“A super-large rate cut to start a rate-cutting cycle when the S&P 500 and Dow Jones are near all-time highs and credit spreads are tight seems only possible if the Fed knows something nobody else knows,” said James St. Aubin, CIO at Ocean Park Asset Management, which has $5.3 billion in assets under management. “I believe the 50 basis point rate cut may do more harm than good to equity market sentiment. There is plenty of room for further cuts if the need arises. We’re just not there yet.”
FMW/Bloomberg
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What are the risks associated with betting on a soft landing in the stock market?
Stock Markets: The Risky Bet on the Fed and a Soft Landing
The past trading week has been a prime example of Wall Street’s current limitless appetite for risk. Just a week ago, the US stock markets had a dismal trading week, with the S&P 500 losing 4.3% due to concerns that the Federal Reserve was behind the curve and the US economy was slowing down. However, this week, the index rose by 4% as traders placed a large bet on the Fed and a soft landing, despite no fundamental changes in the economy.
The Fed’s Dilemma
The Federal Reserve is facing a tough decision regarding interest rates. On one hand, the economy is still growing, and inflation has not been defeated. On the other hand, there are warning signs of a potential downturn, and a rate cut could stimulate growth. The FedWatch tool shows a 50/50 chance of a half-percentage point rate cut, which has led to a surge in sentiment in tech stocks, cryptocurrencies, and junk bonds.
The Goldilocks Scenario
Bulls in the market are convinced that a proactive Federal Reserve, combined with an expanding economy, is the perfect recipe for a continued bull run. According to Priya Misra, portfolio manager at JPMorgan Asset Management, “The best-case scenario for equity markets is good economy, lower interest rates, declining inflation.” This optimism is despite the fact that the economy is still sending warning signals, and there is great uncertainty about the Federal Reserve’s next move.
Market Volatility
The past week has seen a significant turnaround in the Nasdaq 100, which rose by almost 6% in five consecutive days after falling by a similar amount the previous week. This volatility is a result of the market’s sensitivity to the Federal Reserve’s monetary policy decisions. Futures markets have also resumed betting on a big rate cut, despite giving it virtually no chance just days earlier.
The Question Remains
However, the question remains: Why would the Fed cut rates aggressively and sharply when the economy is doing so well and inflation has not yet been defeated? Is the Federal Reserve trying to stimulate growth, or is it trying to prevent a potential downturn? Only time will tell.
The Risks
While the market is enjoying the current bull run, there are risks involved in betting on a soft landing and aggressive rate cuts. If the economy does not respond as expected, or if inflation rises unexpectedly, the Federal Reserve may be forced to reverse its decision, leading to a sharp correction in the markets.
The Bottom Line
the past trading week has been a prime example of Wall Street’s limitless appetite for risk. While the market is betting on a soft landing and aggressive rate cuts, there are risks involved in this strategy. The Federal Reserve’s next move will be crucial in determining the direction of the markets. Only time will tell if the current bull run is sustainable or if it is just a fleeting dream.
Keywords: Stock markets, Federal Reserve, interest rates, soft landing, risk appetite, Wall Street, Nasdaq 100, S&P 500, inflation, economic growth, monetary policy.
Meta Description: The stock markets are betting on a soft landing and aggressive rate cuts, but is this strategy sustainable? Explore the risks and uncertainties surrounding the Federal Reserve’s next move.
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