Wall Street refuses to kick risk addiction in big bet on the Fed
TIME and again, Wall Street’s risk-taking brigade has turned a deaf ear to Federal Reserve policy machinations and shifting economic sentiment in the bond market.
Now – with speculation rampant that Jerome Powell is about to take decisive monetary action – traders are paying attention and ushering in a new round of bulled-up wagers in favour of a soft landing.
Spirits flared anew this week in tech stocks, crypto and junk bonds, with money managers emboldened by an uptick in expectations that policy makers may be poised to deliver a rare half-percentage point cut in interest rates. The reversal in the Nasdaq 100 was especially pronounced, rising almost 6 per cent in five straight days of gains, after plunging by a similar clip the previous week.
It’s the latest twist in a particularly fertile period for market narratives of late. After nearly succumbing to a vision of economic gloom, equity traders convinced themselves that growth is sustainable, especially as a widely expected dovish shift in the monetary regime nears.
A cohort of bulls even see an ideal investing backdrop: A proactive Fed – potentially thanks to extra-large rate cuts – juices a still-expanding economy.
“The best case scenario for stocks: OK economy, lower rates,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “Going 50 is good news. It tells you that the Fed doesn’t want to be behind the curve.”
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Futures markets on Friday saw revived wagers on an outsized reduction in the benchmark rate, just days after assigning little chance to the prospect. The shift extended a spirited rally in stocks seen as beneficiaries – cheap equities, smaller firms and those paying high dividends – while driving down the dollar.
Up 4 per cent over five sessions, the S&P 500 scored its best week since November and now sits within 50 points of its all-time high reached in July. Junk bonds climbed too, with a major exchange-traded fund tracking the asset snapping a two-week decline.
Still, gold prices hit an all-time high this week while 10-year Treasury yields touched a 15-month low, both market moves that can be framed as sour economic signals.
Hotter-than-forecast consumer-price data and the relatively healthy labor market argue for a measured monetary move ahead. Yet economists, such as former New York Fed President William Dudley and JPMorgan Chase’s Michael Feroli, said the Fed should take a deeper cut to avoid falling behind the curve.
“We believe what the Fed should do next week is clear: recalibrate the policy rate 50 basis points lower to adjust for the shifting balance of risks,” Feroli wrote in a note on Friday.
The Fed is walking a fine line, according to Raphael Thuin, head of capital market strategies at Tikehau Capital.
“A 50-basis-point cut by the Fed aimed at addressing a weakening economy could unsettle the market, potentially triggering volatility as we approach year-end,” he said. “On the other hand, if a 50-basis-point cut is made in response to favorable inflation data and comes with reassuring communication from central bankers, it could boost risk assets.”
However policymakers proceed, count the venerable Doug Ramsey as skeptical the celebration stock bulls are preparing for will last long. The chief investment officer at Leuthold Group said special characteristics of the current advance in risky assets likely doom it to a shorter lifespan, among them valuations that were never reset by a full-blown pullback in the economy.
Of the last 12 bull markets, only four had their genesis outside a recession – and those went on only half as long as the others, on average, Leuthold data shows.
“Bull markets lacking the traditional recessionary ‘father figure’ tend to have shorter lives than their genetically superior brethren, and produce an S&P 500 gain only one-third the size,” he wrote in a note. “If the current bull market were to match the average performance of its four most-cyclically relevant predecessors, it would extend until May 2025, with the S&P 500 topping out at 5,852 – about 8 per cent above its Sep 6 close. Not great.”
Caution is echoed among hedge funds, which according to Morgan Stanley’s prime brokerage team cut their net equity exposure to the lowest level since late last year. Broadly, market positioning is getting more vigilant, with US stock funds suffering their largest weekly outflows since April, EPFR Global data compiled by Bank of America show.
Skeptics also note that the pace of rate rates as priced in Fed fund futures – more than two full percentage points over the next 12 months – has rarely been seen outside recessions.
“A super sized cut to kick off a rate cutting cycle when the S&P is near an all-time high and credit spreads are narrow seems it would only happen if the Fed knew something nobody else did,” said James St. Aubin, chief investment officer at US$5.3 billion Ocean Park Asset Management. “I believe the 50 basis point cut can be potentially more harmful than helpful when it comes to sentiment. There is plenty of room to cut down the road if the need arises. We’re just not there yet.” BLOOMBERG
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