Fed impact on Stock market: Why US Fed’s 25 bps rate cut spooked stocks?

The US Federal Reserve did deliver on markets’ expectations of a rate cut on Wednesday but cut short investors’ celebrations soon after when Chairman Jerome Powell said the rate cut was not the beginning of a lengthy cutting cycle.

US stocks, which had inched up after the central bank lowered the target range for the benchmark rate by 25 basis points to 2-2.25 per cent, tumbled on Powell’s comments. The Dow and Nasdaq lost 1.2 per cent each while the S&P500 declined 1.1 per cent.

Asian shares fell to six-week lows on Thursday in reaction to the Fed move. Japan’s Nikkei fell by 0.4 per cent. South Korea’s KOSPI slipped 0.5% while Australian shares declined 0.3 per cent.

“By not coming out and promising more cuts in the future, the market appears to have interpreted this policy move as hawkish,” Reuters quoted John Velis, forex and macro strategist at BNY Mellon, as saying.

“We’re thinking of it as essentially in the nature of a mid-cycle adjustment to policy,” Powell told a press conference. “The current rate cut decision is different from the beginning of a lengthy cutting cycle,” he said. Powell also stopped to say: “I didn’t say it’s just one rate cut,”

The Fed rate cut was first since 2008, as central bank battled to extend a record-long US economic expansion amid mounting global risks.

In its policy statement, the Fed, however, signalled that it was ready to lower rates further if needed. “As the committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labour market and inflation near its symmetric 2 per cent objective,” the policy statement said.

The US dollar rose to $1.063 against the euro, its highest level since May 2017. US treasury yields resumed fall with, rate on 10-YEAR bonds slumping to 2.014 per cent.

Here are key takeaways from the US Fed policy:

Why the Fed move hurt financial markets
You got a negative reaction because you also had a negative reaction in the US markets, said Geoff Dennis, EM Commentator.

“US market probably should not have reacted negatively to the Fed, but it did. The dollar is firmer on the back of Powell’s statement. It tends to be negative for the emerging markets. At this point in time, EMs have been in a pretty tight range for a few weeks. The markets will disappoint you with what the Fed did overnight,” Dennis told ET NOW.

Santosh Rao of Manhattan Venture Partners said the Powell was not very clear and dovish enough for the market.

“While the rate cut was all expected, it was the future rate cut path which was uncertain. We thought of two cuts for sure. That may or may not happen. Powell also did not explain it. That is where the problem is. I hope he comes back in one way or the other and clarifies what exactly he meant,” Rao told ET NOW.

Dennis said if the emerging markets were to take off on dollar weakening and money starts moving out of the US, India would not outperform. “But India will prove to be pretty defensive here in the event that you see a little bit more softening of the emerging markets in the short term,” he added.

“Interest rate cuts normally boost share market sentiment. But financial markets reacted negatively after the Federal Reserve cut interest rates for the first time since December 2008,” said Craig James, chief economist at CommSec, told Reuters.

“In his press conference, Fed Chair Jerome Powell was more ‘hawkish’ than expected, wrong-footing traders who were hoping for a more ‘dovish’ cut i.e. more explicit confirmation of further policy easing,” James said.

Reliance Securities in its note earlier said with one rate cut factored in, the market will be following Powell’s comments for fresh cues. Now, with Powell making it clear that there is no guarantee of more cuts not, it is likely to spook investor sentiment on Dalal Street.

Fed halts balance sheet reduction
The central bank stopped shrinking the balance sheet effective August 1, ending a process that very modestly tightens monetary policy and was previously scheduled to close at the end of September, Bloomberg reported. The Fed’s holdings of government bonds swelled during the financial crisis.

Fed on US economy
The central bank said the labour market remained strong and economic activity has been rising at a moderate rate. “Job gains have been solid, on average, in recent months, and the unemployment rate has remained low,” it said.

Traders’ View
The federal funds futures imply traders see 74 per cent chance of the central bank lowering rates by 25 bps to 1.75-2 per cent in September.

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