(Bloomberg) — Jerome Powell delivered exactly what Wall Street traders had long hoped for: a big interest rate cut that would justify this year’s sharp rally in stocks and bonds as the era of tight monetary policy finally began to reverse.
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Stocks, especially those of economically sensitive companies, briefly rose, sending the S&P 500 (^GSPC) up as much as 1%. The same was true for bonds, while the prospect of easy money ahead initially boosted speculative assets like cryptocurrencies.
As the trading day ended, however, gains faded as a more discouraging economic and market reality became clear. Even with the half-point rate cut (the kind of aggressive measure usually reserved for a recession or crisis) and more on the way, the investment backdrop was no clearer than before.
Stock prices are already near record highs. The economy is losing some steam, and there is no guarantee that the rock-bottom rates that post-pandemic inflation swept away will return anytime soon.
From stocks to Treasuries, corporate bonds and commodities, all major assets fell on Wednesday. While the scale of the declines was smaller, a concerted drop like that had not happened after a Fed policy decision since June 2021. On Thursday, stocks gained some momentum, but the dollar fell and Treasuries rose slightly.
Of particular concern to traders were Powell’s comments that coincided with the reversal in stock and bond markets: that no one should expect the Fed to make a habit of half-point cuts going forward, and that the neutral level of interest rates is likely higher than it was before the pandemic.
“The important thing here is that there is action, in the 50 basis points, and there is anticipation in what was priced in,” Jeffrey Rosenberg, a portfolio manager at BlackRock Inc. (BLK), said on Bloomberg Television. “This is a little disappointing relative to what has built up in bond expectations.”
That was clear in the immediate reaction to the Fed’s announcement. Two-year Treasury bonds, among the most sensitive to policy changes, rose after the announcement but failed to hold on to gains.
Powell sounded optimistic about the economy and dismissed fears of a recession, tempering market expectations about its direction. During his press conference, he said the central bank is confident that “labor market strength can be maintained in a context of moderate growth and inflation moving sustainably toward 2%.” At the same time, he warned against assuming that the half-point move sets a pace that policymakers will maintain, stressing that everything will depend on how the data is released.
The bond market had already been preparing for a series of rate cuts, and bets on Wednesday’s move had built up so much that it was practically already booked in. The yield on two-year Treasuries, for example, had already fallen from above 5% in late April, enough to reflect several rate cuts.
“It was always going to be difficult for Powell to ‘outperform’ the bond market given how much it had moved over the past six weeks or so,” said Michael de Pass, global head of rates trading at Citadel Securities.
While the economy does not appear to be in obvious need of stimulus, there are signs that it is trending toward weakening. The average quarterly increase in nonfarm payrolls is at the lowest level since 2020 and indicators of factory output have retreated.
At the same time, the unemployment rate is just 4.2%, gross domestic product in 2024 is projected to expand at the same pace as last year, and analysts now estimate earnings growth in 2025 for the S&P 500 at 14%. That upbeat backdrop had prompted investors to bid up stocks to near-record valuations at the time of a first rate cut: more than 25 times earnings over the past four quarters.
This may reflect another anomaly of the current moment: The Fed has raised rates so high (about 5.3% before Wednesday’s decision) that it has given traders confidence that it has plenty of room to cut if the economy falters.
“While we can all debate the justified speed of rate cuts early on, the reality is that the direction of travel for policy rates is down,” said Charlie Ripley, senior investment strategist at Allianz Investment Management (ALV.DE). “The track record of this Fed has shown that it has historically not been the quickest to initiate, but it has demonstrated the ability to pick up the pace when deemed necessary.”
However, traders have struggled to predict the Fed’s path since inflation surged in the wake of the pandemic, and Powell’s reliance on incoming data means it won’t get any easier even now that he has changed course.
According to their median forecast, policymakers expect an additional percentage point of cuts in 2025. However, bond traders are still counting on a more aggressive pace.
“A longer, more predictable easing cycle is ahead,” said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management. “It will now be a battle between market expectations and the Fed, and employment data, not inflation, will determine which side is right.”
—With assistance from Vildana Hajric, Liz Capo McCormick, Emily Graffeo, Aline Oyamada and Cecile Gutscher.
(Updated with Thursday’s market moves in fifth paragraph.)
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