Markets had a mixed response to the U.S. Federal Reserve’s rate cut

• The markets eventually decided they loved the Fed's 50-point surprise rate cut.
• Traders expect more cuts, while maintaining confidence in avoiding a recession.
• The Fed shifted focus towards unemployment.

The U.S. Federal Reserve (the Fed) took an unexpected step by cutting interest rates by 50 basis points instead of the anticipated 25. Despite a 70% probability of the eventual rate cut happening (prior to the decision), many were still caught off guard. What surprised markets more, however, was the reaction in the bond market, with some longer-term yields rising instead of falling. This was the Fed's most significant rate cut since the pandemic’s early days, and the market response was mixed. Initial gains in stocks faded, while movements in Treasury securities, corporate bonds and commodities remained muted. However, this early reaction then flipped, with U.S. stock futures hitting record highs, alongside gains in Europe and Asia. Gold neared its all-time high again, and copper prices — leading a surge in base metals — reached their highest level in two months. This shift suggests that the reflation trade (when the economy experiences inflation and asset prices change to reflect that) is slowly returning. 

Fed Chair Jerome Powell emphasized that the cut was meant to reduce the likelihood of a major economic slump but stopped short of committing to further reductions. Interestingly, Fed Governor Michelle Bowman voted against the 50-point cut, preferring instead the 25-point cut; this was the first dissent of this kind from a Fed official since 2005. 

The decision reinforced confidence that the U.S. economy can avoid a recession. A Bloomberg Terminal survey showed 75% of respondents expect the U.S. to sidestep a technical recession by the end of next year. Meanwhile, traders increased their bets on more rate cuts, predicting over 70 basis points of reductions for the rest of the year, exceeding the Fed’s own projections of a 50-basis-point cut. 

The Fed’s statement also saw minor updates: it acknowledged that inflation is going in the right direction but that it still remains somewhat high. It expressed more confidence that inflation is on a sustainable path toward the 2% target and noted that risks to its goals are balanced. However, the overall guidance remained steady, stressing that the Fed will closely monitor data and economic conditions while aiming for maximum employment and 2% inflation. 

So, what does this mean for investors? The market welcomed the news, and we consider this to be a good moment to reassess risk exposure. While we still believe equities have long-term potential, the gap between expected returns for stocks and bonds is shrinking. There’s still a difference, but it’s not as wide as it once was. If the rewards for taking risks aren’t that appealing, why would you overextend yourself? 

Listen to this week’s podcast for further insights.