Wednesday's Market Minute: The Final Cut

There is a good bit of irony coming into today's Federal Reserve decision.

At the time of the last two FOMC meetings in which rates were lowered, the U.S. economic situation was one of stability and obvious strength relative to the rest of the world. The reason for cuts, we were told, was a preventative measure to brace the U.S. for whatever blowback was coming from a global slowdown. Economic data in the U.S. was beating expectations at the time of the last cut, but deterioration in the global economy and fragility on the geopolitical stage gave the Fed clearance to heed the bond market’s stark warning of elevated recession risk as expressed through the inverted Treasury yield curve.

There is now above a 90% chance for another cut today, but the likelihood of another move lower by year-end is small. Fed funds futures suggest just a 25% chance. In other words, today may well mark the final cut of this “mid-cycle adjustment.”

Yet as we head into the apparent sunset of this cut-cycle, it’s actually the domestic data here in the U.S. that’s taken a turn for the worse over the past month. October began with two brutal misses on both manufacturing and services data, and our economic surprise rate has since turned south as misses on things like retail sales and durable goods weighed on our standing over the rest of the world. But here’s the double dose of irony: as our bad data arrived, bond yields rose, the yield curve – gasp! – uninverted, gold sold off, and the stock market set new highs. Progress in global pressure-points like Brexit and U.S.-China trade negotiations have likely played a role in the return of optimism to financial markets, but let’s just be clear about how this played out this summer: The Fed cut rates while the U.S. data was robust and the yield curve was inverting, and will now likely signal an end to those cuts right as our data turned south and our yield curve signals relief. It may sound like bizarre world, but it’s a much-needed reminder that markets are forward-looking, and that the buffer zone provided by this mid-cycle adjustment may prove to be just what the doctor ordered.

It almost seems too perfect. A VIX at 13 again suggests maybe it is. For a stock market that did an epic U-turn last year in anticipation of the Fed’s own reversal, there is an eerie calm ahead of a day where investors are expecting the punch bowl to be taken away. While one could argue that would be just the time for the Fed to withhold the last drop, it probably won’t happen. Even with this morning’s GDP beat, the global outlook remains too tenuous for big surprises. But if today is indeed the final cut, an investor has to ask: what will take the Fed’s place in supporting equity valuations back at a level that’s been short-lived since 2018? Earnings growth at -0.3% this quarter is not the most comforting answer.

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