Source: Jin10 Data
Author: Cai Zijun
After the long-awaited CPI data was released, the stock market experienced significant volatility, with the s&p 500 staging its largest intraday rebound in two years. Despite investors' anticipation of a substantial interest rate cut by the Federal Reserve, the market's response was intriguing.
Traders in the interest rate market still expect a large-scale interest rate cut before the end of the year, reflecting the "worsening panic of recession", according to strategists.
The long-awaited moment for financial market participants has finally arrived this week, but with a bit of a surprise.
The August Consumer Price Index (CPI) results were in line with expectations, further strengthening traders' expectations of a 25 basis point interest rate cut by the Federal Reserve next Wednesday. This should have been welcome news for stock market investors. However, the stock market fell during most of Wednesday's trading session, with the Dow Jones Industrial Average plummeting 743.89 points at one point, marking the largest intraday rebound in almost two years. This has led investors to question whether the Federal Reserve's actions have been too little, too late to timely reduce borrowing costs. The Federal Reserve's federal funds rate target has been kept at a 23-year high of 5.25% to 5.5% for over a year.
After the release of the CPI data on Wednesday, federal funds futures traders still widely expect the Federal Reserve to cut interest rates by at least 100 basis points in the remaining three meetings this year, including next week's meeting, and they anticipate a larger than usual 50 basis point rate cut in November or December. All of this has heightened concerns that the Federal Reserve may be behind the curve, raising doubts about its ability to successfully achieve an economic soft landing.
Lawrence Gillum, Chief Fixed Income Strategy at LPL Financial, said that market prices show "rising concerns about a recession". He also said, "The performance of the current interest rate market indicates an impending recession."
Gillum said over the phone on Wednesday, "Our view is that the economy is slowing down, but we do not believe it will go into a recession, and the interest rate market is mispricing the upcoming rate cuts. Ultimately, the rate cuts will be corrected by the market as we believe there will be no recession in the coming quarters."
Wednesday's market reaction shows just how unusual the current trading environment is. In addition to the CPI data, market participants also reacted to Tuesday night's TV debate between Vice President Kamala Harris and Republican Donald Trump. Harris was seen as the winner in the debate, prompting a reevaluation of the "Trump trade" that had been favorable to certain sectors and industries.
A few days ago, founders like Tom Essaye of Sevens Report Research suggested that if Wednesday's CPI inflation report is weaker than expected and creates market expectations of a 50 basis point rate cut by the Fed on September 18, it would be considered 'good news' for the market and generally welcomed. Meanwhile, market participants like Jay Hatfield, CEO of Infrastructure Capital Advisors, stated that they would consider a 50 basis point rate cut by the Fed next week as a clear signal that the U.S. is heading into a recession.
However, the widely expected substantial rate cut did not materialize. As the implied probability of a 50 basis point rate cut on Wednesday declined to 15%, investors and traders still felt briefly unsettled in the face of the normal 25 basis point rate cut expected this month.
Looking at the widespread expectation of a substantial rate cut in 2024, interest rate traders still seem to be assuming that the U.S. will experience a recession. Meanwhile, the reaction of stock investors to the CPI data release was more volatile: the trend of deflation in the U.S. has made current interest rates too tight, weakened stock valuations, and ultimately increased the risk of future economic recession.
The S&P 500 index later rebounded during Wednesday's trading session as dip buyers emerged, marking the largest intraday rebound for the three major stock indexes in nearly two years. Some analysts have begun to consider that the Fed's rate cuts may be more gradual. Ed Yardeni of Yardeni Research described the initial market reaction to the CPI report as 'temper tantrum'.
"Looking ahead, it is expected that year-on-year inflation will continue to decline," said David Doyle, Chief Economist at Macquarie Bank in Toronto, in a report. Doyle stated, "Our base expectation is that the Fed will cut rates by 25 basis points at each of the upcoming meetings, totaling a 200 basis point reduction over the next 12 months."
At the same time, yields on U.S. government bonds from the 2-year to the 30-year have rebounded from their low point in 2024 as traders evaluate the most likely path for interest rates.
Charlie McElligott, Cross-Asset Strategist at Nomura Securities International, stated that the message from the interest rate market to the Fed is 'very clear: if you choose to cut rates less now, you will be forced to cut them substantially in the future.' "The market's perception is that the Fed's slow rate cut pace will ultimately lead to further slowdown in the economy, forcing the Fed to take more aggressive rate cuts," McElligott wrote in a report.
McElligott wrote, "The market's perception is that the Fed's slow rate cut pace will ultimately lead to further slowdown in the economy, forcing the Fed to take more aggressive rate cuts."
Editor/rice