Stock Market After Fed Rate Cut: All Clear for the Santa Rally?

Key Concepts

Fed Policy Announcement: The recent announcement by the Federal Reserve regarding monetary policy, which has caused market volatility.
Broadcom Earnings: Positive earnings report from Broadcom, contributing to market gains.
Oracle Earnings: Negative earnings report from Oracle, impacting the tech sector.
S&P 500 & NASDAQ Performance: Analysis of the day's and week's performance of these major stock indices.
Yields: The behavior of interest rates, particularly at the front end of the yield curve.
Gold & Silver: Performance of precious metals, indicating a shift in risk sentiment.
US Dollar: The weakening trend of the US dollar against other major currencies.
Bitcoin: Performance of Bitcoin as a measure of risk sentiment.
Balance Sheet Management: Changes in the Fed's approach to managing its balance sheet, including initiating purchases of shorter-term Treasury securities.
Repo Rates: The relationship between repurchase agreement rates and the Fed's target rate.
Technical Adjustment: The Fed's stated reason for its balance sheet actions – to address technical discombobulation in short-term borrowing costs.
Neutral Policy Stance: Fed Chair Powell's indication that current policy is in a "plausible range of neutral."
Non-Farm Payrolls Overcount: The Fed's perception of an overcount in non-farm payroll numbers, suggesting actual job losses.
Inflation Signals: The Fed's assessment of inflation trends, with moderating services inflation and potentially temporary increases in goods inflation.
Productivity Gains: The Fed's positive outlook on productivity and economic growth.
Economic Data Releases: Upcoming key economic data, including payrolls, retail sales, and inflation reports.
Atlanta Fed's GDP Now Model: A model indicating a potential slip in economic vigor.
S&P Global PMI & ISM Numbers: Indicators of economic activity in manufacturing and services sectors.
Goldilocks Scenario: A market scenario characterized by falling interest rates and a strong economy.
Trading Positions: Specback's current investment positions in gold, the dollar, Bitcoin, S&P 500, and bonds.

Market Performance and Fed Policy Aftermath

The market experienced significant volatility following the Federal Reserve's policy announcement, with a "seesaw" day culminating in a relatively strong finish. The S&P 500 managed a gain of 0.4%, largely driven by positive earnings from Broadcom. In contrast, the NASDAQ finished the day flat, having been down as much as 1.6% earlier due to Oracle's disappointing earnings report released after yesterday's close. The NASDAQ remains within its established range, showing only a 0.3% gain for the week and still trading below last week's high. The S&P 500, however, appears to be breaking out, surpassing its highs from last Friday and mid-November, which were around the 6900 level. This rebound is significant given that the S&P 500 was down as much as 1.09% earlier in the day.

Yields and Short-Term Borrowing Costs

The market seems to be coming to terms with the Fed's policy, reflected in a standstill on the yield curve. A notable observation is the continued decline in yields at the front end of the curve. This trend has implications for assets sensitive to near-term US borrowing costs.

Impact on Other Assets

Gold and Silver: Gold experienced a healthy rise, while silver showed even more dramatic gains, indicating a shift in sentiment.
US Dollar: The dollar weakened across the board, down 0.5% against the Euro and 0.4% against the Yen.
Bitcoin: Bitcoin showed a very small gain, appearing more anemic compared to other risk sentiment indicators.

Fed's Policy Statement and Chair Powell's Clarifications

The Fed's policy statement itself showed minimal changes, with the most significant adjustment concerning balance sheet management. The committee now judges that reserve balances have reached ample levels and will initiate purchases of shorter-term Treasury securities.

Fed Chair Powell clarified that this action is intended to address a "technical discombobulation" where repo rates and the Fed's target rate have drifted apart. The Fed aims to make a technical adjustment, which has consequently driven down short-term borrowing costs. This has resulted in a weaker dollar and a resurgence in precious metals like gold and silver.

Powell indicated that current policy is in a "plausible range of neutral" and that the committee is positioned to determine "if" further adjustments are needed, not "when." While rate cuts are not the "best case," Powell clarified that no one is discussing rate hikes, and opinions are relatively balanced.

Fed's Rationale for a Rate Cut

The Fed's decision to cut rates appears to stem from concerns about the labor market. Powell highlighted a perceived "overcount" of about 60,000 per month in non-farm payrolls. With average monthly non-farm payrolls around 40,000, this suggests an average of 20,000 job losses per month, which the Fed aimed to counteract with the cut. However, there seems to be a split within the Fed regarding the need for further easing.

On the inflation front, the Fed sees mixed signals. Services inflation is moderating, which is viewed positively as it's a significant component of overall inflation. Inflation on the goods side is rising, but the Fed considers this a "plausible one-off" due to base effects from year-on-year calculations. The Fed estimates that inflation would be in the low twos if tariffs were removed, providing justification for the rate cut.

Outlook for Next Year and Beyond

The Fed's forecast for next year remains at a single rate cut, contrasting with market expectations of at least two cuts (54 basis points). However, the Fed has upgraded growth expectations while downgrading inflation expectations, suggesting a rise in productivity. Powell expressed optimism about back-to-back years of productivity gains.

The long-term outlook suggests a potential shift towards rate hikes in 2027, though this is not expected to be the immediate driver of policy or market reaction. The market appears to be anticipating a scenario where a well-supported economy receives additional stimulus from the Fed. The divergence lies in the sequencing: the Fed projects one cut next year and another in 2027, while the market expects both cuts next year, leading to a neutral to upside bias by 2027.

Market Expectations and Upcoming Data

The relationship between expected rate cuts in 2026 and rising stock prices is evident. When rate cut expectations diminish, stocks tend to react negatively. The market is currently in a phase where it needs to determine if it can defend current levels or if sellers will emerge due to a less dovish policy outlook. The potential for a "Goldilocks" scenario, where the Fed is cutting rates and the economy is holding up, is a key market aspiration.

Next week's economic data releases are crucial, including October and November payrolls reports, October and November retail sales numbers, and the November CPI report. The market currently anticipates no rate cut in January, with probabilities of a cut only increasing significantly by April.

Economic Indicators and Fed Positioning

The Atlanta Fed's GDP Now model suggests a potential slip in economic vigor, which could justify the Fed's move to cut rates. However, other indicators paint a picture of a relatively solid economy. S&P Global PMI numbers indicate a return to brisk growth, and while manufacturing remains anemic, the services sector, which constitutes 70-80% of the economy, is holding up well and has accelerated in growth over the past two months.

Manufacturing is in contraction, leading to weak demand and cooling inflation in that sector. In services, employment decline is slowing, and disinflation is occurring even as growth holds up, which is positive. Given this data, the Fed is well-positioned to wait and observe incoming data for at least a few months.

Trading Positions and Strategy

Specback has re-entered long positions in gold, which has broken through its range-top around 4260-4270 and is potentially heading towards 4380. He has also flipped to short the dollar, reversing positions in the Euro and Pound after the Fed announcement. A short position in Bitcoin is being maintained due to its inability to find support. The short position in the S&P 500 is being re-evaluated due to the lack of expected reversal at current levels, with a leaning towards closing it with a small loss given the proximity to expiration. Long positions in bonds have been re-established after a brief exit and small loss, as they have rebounded into their range. VIX is considered "tremendously cheap," leading to outright call vertical exposures.

Conclusion

The market is navigating the aftermath of the Fed's policy announcement, with a focus on the divergence between Fed projections and market expectations for future rate cuts. Upcoming economic data will be critical in shaping sentiment and determining whether the market can sustain current levels or if a reversal is imminent. The potential for a "Goldilocks" scenario remains a key driver for market optimism.