Rally Fuel: Fed Expectations Into Jackson Hole

By in
Rally Fuel: Fed Expectations Into Jackson Hole

One of our four “signs of a bottom” for US stocks has been if Fed Funds Futures became convinced the US central bank was about to cut rates by 50 basis points at its September 19th meeting. Our thinking was that this would put a floor under US equity prices, reassured a “Fed Put” was solidly in play.

Today we’d like to expand on that thought with an alternative narrative: markets may be sufficiently appeased if they strongly believe the Fed will embark on a steady diet of rate cuts through the rest of 2019. While not as immediately gratifying as a sharper drop in rates, this might also do the trick.

Importantly, Fed Funds Futures prices around upcoming FOMC meetings are now pointing solidly in this direction:

September 19:

  • 95% odds of a 25 basis point rate cut, up from 75% a week ago.
  • Just 5% odds of a 50 bp cut, down from 25% a week ago.

October 30:

  • 73% odds rates will be 50 basis points lower than today, essentially pointing to a 25 bp cut at this meeting. Odds for this outcome a week ago were lower, at 62%.
  • Only 4% odds rates will be lower than this, down from 18% last week.
  • Just 23% odds the Fed will not reduce rates at this meeting, essentially the same as last week’s 21%.

December 11:

  • Futures make the possibility of another rate cut here at essentially 50-50, with 44% odds on either no more rate cuts or one more to end the year. The odds a week ago were 40% – 41%, so the market is clearly tightening up around these two potential outcomes

Our takeaways from this market-based data:

#1: Increasing confidence that the Fed will embark on a series of steady-Eddie rate cuts has put a temporary floor underneath US stocks. Yes, some recent rumblings that the German government might actually provide fiscal stimulus in the event of a recession have helped global stocks as well, along with some temporary softening of US-China trade rhetoric. But the action in Fed Funds Futures is a better explanation of the last 2 days of higher equity prices. Much better, in our book.

#2: The bar is therefore quite high for Fed Chair Powell’s Friday comments at the central bank’s annual Jackson Hole conference. His last press conference after the July FOMC meeting left real doubt about the Federal Reserve’s future course of action. Markets think he will be clearer at the end of this week. Clearly dovish, that is.

#3: The combination of those two issues makes it hard to believe US equities are in the clear just yet. Markets have an increasingly specific perspective: the Fed needs to be in the game at every meeting through the rest of the year. The Federal Reserve itself may not want to be so transparent on Friday. Will they give a nod to lower rates? Certainly… But endorsing a set of every-meeting cuts seems a bridge too far.

Bottom line: as welcome as the recent lift off the August lows has been, we remain cautious on equities. Yes, the Administration’s tariff reprieve has allowed us to exhale. But there are still 2 weeks left in August, and our Strong January Playbook says stocks still have to come to terms with a more important issue. They think they know exactly what the Fed will do. Seeing them do it… That’s another matter entirely.

CME FedWatch Tool: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

December 2019 Fed Funds Futures Probabilities