Powell delivers the rate cut Wall Street most wanted! But the market remains full of doubts

Federal Reserve Chairman Powell has fulfilled the long-awaited promise of Wall Street traders: a substantial rate cut, providing a legitimate reason for the strong rebound in the stock and bond markets this year, marking the beginning of a reversal of the era of tight monetary policy. On Wednesday, U.S. stocks, especially stocks of companies sensitive to the economy, briefly surged, pushing the S&P 500 index up by as much as 1%. The bond market followed suit, and the prospect of future loose monetary policy initially boosted speculative assets such as cryptocurrencies. However, by the end of the trading day, the gains had gradually faded. Even though the Fed's rate cut reached 50 basis points, and further cuts are expected in the future, the investment environment is not clearer than before. The U.S. stock market is nearing historical highs, economic growth is slowing down, and it is still uncertain whether the ultra-low interest rates caused by post-pandemic inflation will return soon. From stocks to government bonds, from corporate bonds to commodities, all major assets experienced declines on Wednesday. Although the declines were not significant, since June 2021, there has not been such a consistent pullback following a Fed policy decision. What particularly concerns traders is that Powell made a statement at the same time as the reversal in the stock and bond markets: the Fed will not habitually cut rates by 50 basis points in the future, and the neutral interest rate level may be higher than before the pandemic. "It is important to emphasize that the 50 basis point rate cut was already priced in and reflected in the market," said Jeffrey Rosenberg, portfolio manager at BlackRock. "It is somewhat disappointing compared to bond market expectations." This was evident in the immediate reaction after the Fed's announcement. The S&P 500 index briefly hit an intraday historical high before falling back. The two-year U.S. Treasury yield was the most affected by the policy change, dropping to an intraday low of 3.54% but ultimately closing higher. The 10-year U.S. Treasury yield followed suit. Powell expressed optimism about the economy and downplayed concerns about an economic recession, thereby dampening market expectations for the economic outlook. He stated at a press conference that the Fed believes "with the economy growing moderately and inflation continuing to decline to 2%, the strong labor market can be maintained." At the same time, he warned against assuming that a 50 basis point rate cut will become the "norm" and emphasized that everything will depend on data performance. The bond market had already priced in consecutive rate cuts by the Fed, which was reflected in prices. For example, the two-year U.S. Treasury yield has dropped significantly from over 5% at the end of April, enough to reflect multiple rate cuts. "Given the significant volatility in the bond market over the past six weeks or so, Powell found it difficult to be more 'dovish' than the market," said Michael de Pass, Global Head of Rates Trading at Citadel Securities. Although the economy does not seem to require significant stimulus, there are signs that economic growth is slowing down. The three-month average increase in nonfarm payrolls is at its lowest level since 2020, and factory output indicators have also declined Meanwhile, the unemployment rate is only 4.2%, with GDP growth expected to remain consistent with last year in 2024. Analysts currently project a strong 14% earnings growth for the S&P 500 index in 2025. This optimistic backdrop has led investors to push the stock market to valuation levels almost unprecedented before the first rate cut: earnings over the past four quarters have exceeded 25 times. This may reflect another anomaly in the current situation: the Federal Reserve has raised rates to such high levels, around 5.3% before the first rate cut. This has convinced traders that if the economy slows down, the Fed still has a lot of room to cut rates. "Although we can all discuss the appropriate pace of rate cuts, the reality is that the direction of policy rates is downward," said Charlie Ripley, Senior Investment Strategist at Allianz Investment Management. "The Fed's track record shows that they haven't always been the quickest to act in the past, but they have shown the ability to accelerate when necessary." However, since inflation has soared since the pandemic, traders have been struggling to predict the Fed's path of action, and Powell's reliance on future data means that even if the Fed changes direction, predicting its path of action will not be easier. According to the Fed's median forecast, policymakers expect another percentage point cut in 2025. However, bond traders still expect the rate cut to be faster. Jack McIntyre, Portfolio Manager at Brandywine Global Investment Management, said: "A more enduring and predictable easing cycle is on the horizon, and now it will be a battle between market expectations and the Fed, with employment data rather than inflation data determining who is right."