By Saqib Iqbal Ahmed, Suzanne McGee and Carolina Mandl
NEW YORK (Reuters) – Investors who anticipated wild swings in markets following the U.S. Federal Reserve’s sharp rate cut saw a more muted reaction, which may prove temporary.
Traders had faced a great deal of uncertainty as they awaited the expected rate cut on Wednesday, with a split between those expecting 50 basis points and those expecting 25 basis points. The Fed cut rates by an unusually high half percentage point.
But while the market reaction was muted, with stocks and the dollar reversing their positions to close the circle, another wave of action could be in store. Some specifically pointed to the risk that bond yields could spike after Wednesday’s rise.
“I think the calm is not going to last,” said Brian Jacobsen, chief economist at Annex Wealth Management, which oversees $5.5 billion in assets. He noted that a reversal in equities late in the day could set the market up for weakness in stocks “unless and until we get some data that gives us a clear idea of the direction.”
Jacobsen said the market will focus on upcoming data, such as Thursday’s initial jobless claims.
“The Fed is clearly trying to make up for lost time with the rate cut it just made,” Jacobsen said.
There could also be a domino effect if the Fed’s decision spreads to other markets.
“The next few hours could prove dangerous… with traders exposed to sudden high tides as rate expectations strengthen in other economies,” Karl Schamotta, chief market strategist at payments firm Corpay, said of currency markets.
“Aftershocks are likely to continue as positioning adjustments are made.”
SILENCED REACTION
According to options analytics service ORATS, stock options had forecast a swing of about 1.1%, up or down, for the S&P 500. But by the close of trading, the index had snapped a seven-day winning streak and ended down 0.29%, reversing earlier gains.
One reason for the muted market reaction in close-to-close trading has to do with the performance of asset prices in the days leading up to the Fed’s decision, said Sonu Varghese, global macro strategist at Carson Group. Through Tuesday, the Russell 2000 had gained 5% in the previous five sessions and the dollar had fallen 0.7%, on expectations that the Fed’s long-awaited rate-cutting cycle would begin.
“It’s a very silly cliché, ‘buy the rumor, sell the news,’ but that’s what happened,” said Matt Diczok, head of fixed-income strategy at Merrill and Bank of America Private Bank.
The dollar index initially fell on Wednesday but recovered to trade 0.1% higher at 100.981.
“Since this policy change was largely announced, there is not a huge move in financial markets,” said Jack McIntyre, portfolio manager at Brandywine Global.
However, bonds saw significant movement: the 10-year yield rose seven basis points on the day, while the 2/10 US Treasury bond yield curve hit its steepest level since July 2022, after the rate cut, indicating long-term expectations of higher inflation and growth.
Treasury yields, which move inversely to prices, had fallen to their lowest levels since mid-2023 in the days leading up to the decision.
In a research note, Julian Emanuel, senior managing director at Evercore ISI, recommended positioning for a rebound in yields and that the Fed’s progress on inflation could slow or stagnate.
Small-cap stocks, which had initially bounced, ended unchanged. Traders’ initial reaction was to lift the small-cap-focused Russell 2000 index by nearly 1% in the minute immediately following the Fed decision, representing the index’s biggest one-minute percentage gain in at least three months, according to LSEG data.
Smaller businesses tend to rely more on loans, and lower interest rates reduce their financing costs, boosting their profitability and growth.
“Seeing the jump in small-caps specifically, the market is buying what the Fed is saying, that they will continue to cut rates next year and that’s a potential tailwind for small-caps,” said Ryan Detrick, chief market strategist at Carson Group.
But the Russell index closed the day up just 0.04%.
Federal Reserve Chairman Jerome Powell said at the meeting that the rate cut marked a “strong start” to protecting the economy’s strength.
Still, the massive rate cut could be interpreted more alarmingly.
“I think there will be a lot of profit-taking by investors who entered the equity market throughout the day to participate in this event and it’s quite possible that we will trade lower as the market continues to wonder what is scaring the Fed that we can’t see,” said Matthew Rowe, head of portfolio management and cross-asset strategies at Nomura Capital Management.
(Reporting by Saqib Iqbal Ahmed, Suzanne McGee and Carolina Mandl; additional reporting by Davide Barbuscia and Michelle Price; editing by Megan Davies and Rod Nickel)