Finance

Here’s what the stock market liked from the Fed

The Fed came very close to promising a rate cut Wednesday, and now markets are focused on a possible July rate cut.

“I think they’re fully planning on cutting in July, absent stronger data,” said Ed Keon, QMA chief investment strategist. “The market liked it now, but it’s important to keep in mind, rate cuts are not a magic wand. There is clear evidence of weakening of economic conditions.”

The Fed sent a dovish message in its statement, but even more so in its interest rate forecast, released following its two-day meeting Wednesday afternoon. After the statement, stocks and bonds flip flopped before settling into a pattern, where both markets were bid higher on the prospect of rate cut. Bond yields, which move opposite price, fell with the biggest decline in the 2-year yield, which closely follows Fed expectations.

The Fed’s rate policy committee left the fed funds target rate range unchanged at 2.25 to 2.50%, while it tweaked some of the language in its statement to suggest it sees more risks to the economy. It also removed the phrasing that it would be “patient,” language it added earlier this year to indicate Fed officials were willing to wait and see more information before making a rate move.

Analysts focused on the fact that the Fed’s interest rate projections showed eight of 17 officials are now expecting the Fed will need to cut rates at least once this year. The fed funds futures market Wednesday afternoon moved to price in three quarter point hikes this year, including 100% odds for a quarter point hike this summer, according to BMO.

“That was the biggest surprise in terms of the dovishness. The market was already heading in fairly dovish and everyone did anticipate them taking out the word ‘patience,'” said Leslie Falconio, senior strategist with UBS Global Wealth Management Chief Investment Office. “It was really the dot plot that came off on the dovish side.”

She also noted that the Fed’s interest rate forecast, presented in the so-called ‘dot plot,’ also showed the Fed’s rate forecast falling from 2.6% in 2020 to 2.4%, pricing at least one rate cut. Fed officials’ interest rate forecasts are included anonymously in the dot plot, which literally is a chart.

“They’re setting us up for a rate cut, but who knows when,” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. “If the data weakens, they’ll cut in July. If it stays steady or gets better, they won’t. People should understand if they’re going to cut it’s because the market data got worse…This is showing the market focus is on the cuts but not on the reason for the cuts.”

While the markets took the Fed as dovish and ready to move, some economists stuck with their forecasts for no cuts.

“The market reacted dovishly to the June FOMC, in part reacting to 8 dots showing cuts in 2019 and 7 of these indicating 50bp of cuts. While the statement and dots keep cuts as early as July squarely on the table, the outcome is very close to our expectations and does not change our base case for no cuts in 2019 – which also remains the base case of a slim majority of Fed officials,” Citigroup economists wrote.

But John Briggs, head of strategy at NatWest Markets, said the Fed should already have cut and it loses control of the narrative around the rate cut if it waits.

“If seven of them think they need to cut twice in 2019, what are they waiting for?” said Briggs. “They’re going to have to follow the market…granted the majority didn’t think they needed it but this is an awful fine line.”

Falconio said it looks like a cut is coming but the market may be expecting too much. “I think we have to wait to see what happens but I think July might be premature. I think we have to wait to see what happens at the G-20,” she said.

Analysts said the Fed, like the markets, is watching the upcoming G-20 meeting at the end of the month, where President Donald Trump is expected to meet China President Xi Jinping to see there is a chance to resolve the trade war.

Fed Chair Jerome Powell, speaking to the press after the meeting, said the Fed needs to see more data to determine whether the recent weakness in things such as jobs creation was temporary or a trend. In May, just 75,000 jobs were added.

“We want to see and we want to react to developments and trends that are sustained and genuine,” said Powell. He also said the Fed is concerned by both trade conflicts and the slowing in the global economy.

“We’ll use our tools as appropriate to sustain the expansion,” said Powell.

The S&P 500, which has ended nine of the last 10 Fed days negative, rose 8 points to close at 2,926. The 2-year yield fell to 1.74%, from as high as 1.91% earlier in the day. The 10-year yield was at 2.02%.

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