We Need to Prepare for a Disappointing Week for Stocks
After a disappointing month of May which saw markets decline by 6%, putting a real dent into the 2019 rally, things turned around in June. The Fed likely will crash the party this week.
We can’t ever know for sure how much expectations of a Fed rate cut have been priced into the market so far, but we may not have to wait very much longer to find out. The Fed’s Open Market Committee, the one that decides whether to raise or lower their overnight rates, are meeting this coming Tuesday and Wednesday. After the meeting is over, the cat will be out of the bag.
Federal Reserve meetings perk the ears of the market up any time they occur, but this one will likely be of above average significance, given the expectations this time. Stock markets put a lot of weight on the Fed’s rate decisions, and even when no action is announced, this can move stock markets quite a bit.
If anything, these decisions appear to have even more effect upon the market over the last 6 months than normal, perhaps since many see the bull’s tank running close to empty and they are hoping that the Fed will fill it up some more.
We might think that the stock market puts too much weight on overnight rates, and from an economic standpoint we may wonder why the market cares so deeply about these things that they will trade a little more hope of a rate cut for a new tariff war, but stock market moves are simply what they are and the best we can do is look at what drives them and base our predicting upon what happens rather than what we think should happen.
Stock markets do dance to the beat of their own music and if we don’t realize this, we can get pretty lost trying to figure all this out. If the market places interest rates above everything else, that’s just the way it is, and we need to take these actions seriously and not even judge them.
Anyone who doesn’t put this issue at the top of their list of things to watch is not going to be dancing to the same tune at all. If, for instance, you’re wondering where either the market or stocks that you are watching will be going this week, keep a close eye on what the Fed has to say on Wednesday.
You don’t even have to listen to the announcement in fact, you can just watch the charts of the major indexes around this time and they will tell a clear story of what just happened no matter what else might be going on in the market that day.
This is not just about whether we get a yea or nay on the rate cut, as the side commentary matters as well, especially given that it is not that likely at all that we’ll see the thumbs down that the market is hoping for. If the decision is no, we’ll at least get an indication of where they may be leaning in next month’s meeting, as well as what they are looking to see in order to pull the trigger next time.
Excess Optimism About Rate Cuts Most Often Leads to Disappointment
For whatever reason, perhaps due to positive bias or just pure hope, we tend to be overly optimistic with these things, and that’s the case with this decision as well. If we’re looking to get our predictions more accurate, we need to look at what the Fed would be needing to see to cut rates and then ask ourselves if we’ve seen enough of a change from last time to make them want to do this.
In the earlier part of the year, around the time that they decided that we probably won’t see any more rate hikes, there were still some members who felt that a rate hike would be a good idea and even needed. The raise it up again crowd got outvoted though, and rates stayed the same, although no one wanted to cut them back then either.
There’s no reason to believe that this hasn’t changed, and we really haven’t seen anywhere near enough that we may reasonably expect that the Fed’s view has been altered just yet. President Trump slapping those tariffs upon Mexico still wouldn’t have been enough, but the effect of them might, and this would have been something that would really have affected economic growth in not a good way should they have had a chance to bring us down in the manner they would have at the top end of this threat.
These tariffs got called off, and we were left with the promise that if growth does decline enough, we will get some help, but we really need to ask ourselves if this is the case now or not. It clearly does not appear to be, because we’re not seeing it happen yet.
Other things may slow down our economy of course, including a continuation of the downward momentum that we’ve seen lately, but the Fed is really waiting for the bell to ring to jump in. It might ring soon but it is not ringing yet.
People on Wall Street will bet on just about everything though, and the Federal Funds futures market is one of the things that they bet on, or rather, financial institutions bet on them. This is used as a hedge for big banks the same way as wheat is used by wheat farmers and buyers, and it’s been calculated that these futures have priced in about a 25% chance of a rate cut this week.
That does seem to be quite high under the circumstances, but nothing like the 86% chance that they will cut rates in July. This market also expects two further rate cuts this year, and three rate cuts in 2019 just seems pretty far out there given the current data.
We Need to Keep Our Expectations Reasonable
We don’t just want to look at this due to the fact that there’s a lot of hedging and speculation going on here and this can influence the results to be sure. If you asked one of the committee members on the Fed whether they expect to see three rate cuts this year they would probably either glare at you in disbelief or perhaps even laugh.
Three rate cuts in 6 months is the sort of thing that you would see in a crisis, and we’re far from any crisis right now. Perhaps we will see an economic pullback of the nature that would be met with a response like this, but there isn’t even the basis for a single rate cut on the table right now, let alone three of them by the end of the year.
Should things decline enough, a rate cut in July may be a real possibility, and we’re close enough that it’s fairly conceivable that we might see it in another month. On the other hand, the clouds on the horizon are not all that dark yet, and if a storm comes, it may be further down the road than July and may not even come at all this year depending on how things go.
Current economic forecasts have us within the safety zone and even close to the ideal in fact, and although these forecasts are just predictions, when you are seeing this still in good shape, it’s not time to get too excited about this just yet.
We need to realize that the Federal Reserve manages the economy of the United States only, and while economies are all related these days, the U.S. numbers are the ones that we need to look at. This is in the green right now in spite of so many people mistakenly thinking that it is in the yellow or even in the red.
Those who are rooting for a rate cut will pore over all sorts of economic numbers in search of reasons why the Fed should act upon their preferences, but it’s the overall picture that really matters. The reason why the Fed didn’t cut rates last time wasn’t just because unemployment is so low, it was because growth was already in an acceptable range, where it remains now.
We don’t want deflation by any means, but inflation is also in the healthy range and is expected to remain there. Sure, the tariff war with China has had an impact, but all that has seemed to do is remove reasons to put rates up some more, and given the market’s preference for rates, this trade war may actually have been bullish for the stock market instead of the other way around.
The most likely scenario is that no change will be announced and the market will collect itself and give back some or all of these recent gains that this renewed hope has inspired. Beyond that, we’ll just have to see how it goes, but don’t bank on any moves before you actually see enough of a reason to act. Right now, we really don’t have much to work with.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
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