Investors who originally expected that the market would experience volatile fluctuations after the significant interest rate cut by the Federal Reserve found that the market unexpectedly performed moderately, but this may be short-lived.

Traders faced high uncertainty while waiting for the Federal Reserve to announce its interest rate decision. The possibility of a 50 basis point or 25 basis point rate cut was very close, but in the end, the Federal Reserve chose an unusually aggressive move.

The market's reaction to this was subdued, and the stock market and the US dollar remained relatively stable after reversing their trends. Nevertheless, a new round of turbulence may be on the horizon. Some people specifically mention the risk of further surges in US bond yields after they rose on Wednesday.

"I don't think this calmness will last," said Brian Jacobsen, Chief Economist at Annex Wealth Management, which manages $5.5 billion in assets. He pointed out that the reversal of the US stock market later in the day could lay the groundwork for a weak stock market, "unless we get some data that gives the market a clear sense of direction."

Jacobsen said that the market will focus on upcoming data releases, such as the initial jobless claims report on Thursday.

"The Federal Reserve is clearly in catch-up mode and is trying to make up for lost time through the recent rate cut," Jacobsen said.

As the Federal Reserve's decision ripples through other markets, it may also have a chain reaction.

"The next few hours could be dangerous... as expectations for interest rates in other economies strengthen, traders may be exposed to sudden volatility." In addition, "with the adjustment related to positions taking effect, aftershocks are likely to continue."

Mild market reaction

Data from options analytics service provider ORATS shows that stock options prices are priced for approximately 1.1% volatility in the S&P 500 index. However, the index ended its 7-day rally with a closing drop of 0.29% on Wednesday, reversing earlier gains.

Sonu Varghese, Global Macro Strategist at Carson Group, said that one reason for the market's tepid reaction towards the end of the session is related to the price behavior of assets in the days leading up to the Fed's decision. As of Tuesday, the Russell 2000 index had risen 5% over the past five trading days and the US dollar had fallen 0.7% as market expectations built for the long-awaited rate-cut cycle by the Fed.

"Buy the rumor, sell the fact" may be a cliché, but it's true." Matt Diczok, Head of Fixed Income Strategy at Merrill Lynch and Bank of America Private Bank, said.

On Wednesday, the US dollar index initially declined but later rebounded, rising 0.1% to 100.98.

"Since the Fed's policy moves to lower interest rates have essentially been absorbed, there has not been significant market volatility." said Jack McIntyre, Portfolio Manager at Brandywine Global.

However, there have been significant changes in the bond market, with the 10-year US Treasury yield surging 7 basis points on the day, and the 2/10-year US Treasury yield curve reaching its highest level since July 2022 after the rate cut, indicating long-term expectations for higher inflation and economic growth.

In the days leading up to the release of the Fed's interest rate decision, the yield on US Treasury bonds, which is inversely related to prices, has fallen to its lowest level since mid-2023.

In a research report, Julian Emanuel, Senior Managing Director at Evercore ISI, suggested preparing for a rebound in US bond yields, and that the Fed's progress on inflation may slow or stagnate.

In the stock market, small-cap stocks, which initially rebounded, eventually closed flat. According to LSEG data, the small-cap focused Russell 2000 index rose nearly 1% within a minute after the Fed's decision, marking its largest single-minute percentage increase in at least three months.

Investors favor small-cap stocks after the Fed's rate cut because smaller companies typically rely more on borrowing, and lower interest rates reduce their financing costs, thereby enhancing their profitability and growth.

Ryan Detrick, Chief Market Strategist at Carson Group, said, "The jump in small-cap stocks particularly underscores the market's belief in the Fed's statement that they will continue to cut rates next year, which could be beneficial for small-cap stocks."

However, the Russell 2000 index only closed up 0.04% on the day.

Fed Chair Powell said at the meeting that the rate cut marked a "strong start" in protecting economic strength. Nevertheless, concerns remain about a significantly larger rate cut.

Matthew Rowe, Head of Portfolio Management and Cross-Asset Strategies at Nomura Capital Management, said, "I do think that investors will take profits, and the stock market may decline because the market continues to question what the Fed is afraid of and we can't see it."

Editor/Lambor