FOMC divided on path for rate cuts

Key Concepts

Federal Reserve (Fed) Interest Rate Cut: A reduction in the target range for the federal funds rate, influencing borrowing costs throughout the economy.
Intraday Records: Stock market indices reaching their highest points within a single trading day.
Valuation: The estimated worth of a company, often measured by market capitalization.
Tariffs: Taxes imposed on imported goods, potentially impacting consumer prices and business ordering.
Earnings Estimates: Projections of a company's future profitability.
EPS (Earnings Per Share): A company's profit divided by the number of outstanding shares.
Monetary Policy: Actions undertaken by a central bank to manipulate the money supply and credit conditions to stimulate or restrain economic activity.
Federal Funds Rate: The interest rate at which depository institutions trade federal funds (balances at the Federal Reserve) overnight.
Neutral Stance: A position where the central bank is neither actively stimulating nor restraining the economy.
Policy Rate: The interest rate set by a central bank that influences other interest rates in the economy.
Selloff: A rapid and significant decline in asset prices.
Bond Yields: The return an investor realizes on a bond.
Shutdown: A situation where government operations are halted due to a lack of funding.
Jobless Claims: Weekly data reporting the number of people filing for unemployment benefits.
Job Openings: Data indicating the number of available positions in the labor market.
Monetary Policy Terms: Language and concepts used in discussions about central bank actions.
Dissent: Disagreement within a committee or group, particularly on voting for policy decisions.
Basis Point (bp): One-hundredth of a percentage point (0.01%).
Hawkish Position: A stance favoring tighter monetary policy, often associated with higher interest rates to combat inflation.
Dovish Position: A stance favoring looser monetary policy, often associated with lower interest rates to stimulate economic growth.
Consensus: General agreement among members of a group.
Core PCE (Personal Consumption Expenditures) Price Index: A key inflation measure favored by the Fed, excluding volatile food and energy prices.
Transitory Inflation: Inflation that is expected to be temporary and short-lived.
Neutral Rate of Employment: The rate of unemployment at which inflation is stable.

Fed Rate Cut and Market Reaction

Following the Federal Reserve's interest rate cut this afternoon, three major stock indices reached intraday record highs. However, only the Nasdaq managed to close in positive territory. The S&P 500 remained virtually unchanged, while the Dow Jones Industrial Average experienced a decline of over 70 points.

Nvidia's Historic Valuation

Nvidia achieved a significant milestone, becoming the first company to reach a market capitalization of $5 trillion. The company's stock has seen a substantial surge, increasing by nearly 15% in the last five trading sessions.

Gold and Adidas Performance

Gold prices settled back above the $4,000 level today, though they experienced a pullback in the latter hours of trading. In contrast, shares of Adidas saw a significant drop of more than 10% due to weak sales in North America. The CEO of Adidas attributed this to US retailers ordering less product upfront, anticipating the full impact of tariffs.

After-Hours Trading and Earnings Reports

Several companies reported after the market close:

MGM missed earnings estimates.
eBay experienced a decline despite exceeding EPS and revenue expectations, as it cut its Q4 earnings estimates.
Carvana dropped in after-hours trading, even though it reported a revenue beat.

Fed Chair Powell's Stance on December Rate Cut

Federal Reserve Chair Jerome Powell tempered market expectations for a December rate cut, suggesting a more neutral stance due to ongoing economic uncertainty. Traders are now pricing in a greater than 30% probability that interest rates will remain unchanged at the central bank's final meeting of 2025.

Divided Fed and Market Disappointment

Steve Leeman reported from Washington D.C. that the Fed's decision to cut rates by a quarter point, bringing the new range to 3.75% to 4%, was as expected. However, Fed Chair Powell's press conference signaled a less committed approach to a December rate cut than the market had anticipated. Powell stated, "In the committee's discussions at this meeting, there were strongly differing views about how to proceed in December. A further reduction in the policy rate at the December meeting is not a foregone conclusion. Far from it. Policy is not on a preset course."

This statement triggered an immediate selloff in stocks and a surge in bond yields as markets adjusted to the increased possibility of no December cut. The probability of a December rate cut fell from 84% before the press conference to around 67%, while the chance of a cut in January rose from 42% to 80%. This indicates that while the direction of rate cuts remains priced in by markets, the pace is now in question.

Economic Data and Fed's Focus

The Fed acknowledged the lack of data resulting from the government shutdown but appeared more focused on the available economic indicators. These include reasonably strong economic growth, a booming stock market, and no discernible acceleration in the softening of the job market.

Dissenting Votes and Policy Implications

The rate cut decision was accompanied by two dissenting votes:

New Fed Governor Steven Meyer advocated for a 50 basis point rate cut.
Kansas City Fed President Jeff Schmidt maintained a hawkish position, favoring no change in interest rates.

The uncertainty surrounding the default position was highlighted, with the possibility that if alternative data continues to show economic stability, the Fed might opt against further cuts in December.

Powell's Use of Shutdown as Justification

It was noted that Fed Chair Powell seemed to use the lack of government data due to the shutdown as an argument to remain on the sidelines and not move on rates. This was interpreted as a way of shifting responsibility back to the administration. However, the focus on existing data, such as weekly jobless claims and job openings, which show no significant deterioration, is also crucial. The core question in monetary policy terms is whether the Fed has adequately insured against a potential, rather than actual, weakening in the job market.

Historical Dissent and Market Expectations

Regarding the level of dissent, it was questioned how it compares historically and how it impacts policy decisions. It was pointed out that market disappointment often arises when expectations for rate cuts are baked in but do not materialize. The message from the Fed appears to be clear: unless the data shows a significant and sustained weakening, a December cut is unlikely. With a 70% chance still priced in by the market, there's a potential disconnect in understanding.

Inflation and Job Market Data

The Fed has faced challenges in justifying further cuts due to persistent inflation. Core PCE is rising, and while inflation missed expectations by a small margin, the trend is upward. The argument that tariff-related inflation will be transitory is met with skepticism. Furthermore, a paper from the Dallas Fed suggests that the neutral rate of employment is around 30,000 jobs per month, while current job creation is around 50,000, indicating a weaker labor market than needed for neutrality. This data suggests no compelling reason for a December rate cut, presenting a significant risk to markets.

Conclusion

The Federal Reserve's recent interest rate cut was accompanied by a cautious tone from Chair Jerome Powell regarding future policy. While the market had priced in a December rate cut, Powell's remarks, coupled with dissenting votes and a focus on available economic data, suggest that such a move is not guaranteed. The ongoing economic uncertainty, including the impact of tariffs and the government shutdown, adds complexity to the Fed's decision-making process. The market's expectation of continued rate cuts may be misaligned with the Fed's current assessment of the economy, posing a potential risk to asset prices.