The Federal Reserve is in the middle of a two-day meeting, with all of the Fed governors, to discuss the possibility of another rate cut in the Fed Funds Rate. We recently had a 0.25% cut and there is a high probability that another similar cut will be announced tomorrow. The Fed and Chair Powell are in an unusual situation as our economy is quite strong, but they face pressure from the stock market that is seeking larger cuts (0.50% now) and the President who wants the Fed Funds rate to eventually go to zero, which is quite unbelievable. The President has also been tweeting negative comments towards Powell, where he called him an "enemy" of the United States, at one point. Now, we don't believe that a rate cut is being influenced by the market or the President, but its more likely an insurance cut, as an unraveling of the trade talks with China is still quite possible. Of course, we will go through the typical "cat and mouse" game as every word spoken by Powell will be analyzed by humans and algorithms, in order to try to get a jump on the decision. The market tends to price these moves in and we would see much more volatility, now, if the fear of a "no cut" decision was a reality. But no one really knows what will happen.
We would prefer that the Fed take a step back and let the trade talks play out further, as we expect some sort of "mini deal" that will satisfy Chinese citizens and American voters. This way, the Fed, can keep its "ammo" for a worse situation, like a major global recession. Now its true that a global trade war would push most of the major economies into a recession, as China and the U.S. are the two biggest traders, and the largest economies in the world.
Another factor that was pushing the Fed closer to a cut, over the summer, has been the falling global bond yields that have also been pressuring our treasury yields lower, and to the point where we were experiencing yield curve inversions on a couple of key points on the curve. We have recently had a rebound in yields (chart below), which has calmed the market. If global investors continue to get spooked by lower or negative yields, they will be forced to keep pouring into our markets which eventually puts more pressure on yields, as the prices go higher.
Even though the market is anxious about tomorrow, we still expect the 0.25% rate cut, and it will likely push the S&P 500 close to, or above, the all-time high. But we expect this upward move to be temporary and the market will test the all-time high a few times. We cant project where it might settle, but the weight of the trade talks will continue to tamper much larger moves upward. If we don't get a rate cut, the market will head lower to retest lower levels (see chart below).
A few other global risk factors that could also weigh on the markets are whether Germany will be able to stimulate its economy in order to withstand falling into a recession. Also, BREXIT is still quite an unstable policy as no one can agree on how to proceed with a separation from the EU. Recently, Boris Johnson (PM), lost a vote of confidence as he was trying to push BREXIT through as a "no-deal" withdrawal. Another boiling point could be arising in the middle east with the recent attack on Saudi oil fields. Fingers are being pointed at Yemen, and more specifically towards Iran. Any escalation or retaliatory attacks could put pressure on global markets.
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Chief Investment Officer
AETOLIA CAPITAL LLC
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