Big Move from the Federal Reserve on the Horizon? Market Bets on a 50 Basis Point Rate Cut, Tech Stocks and Junk Bonds Celebrate!

The market widely expects Federal Reserve Chairman Jerome Powell to take decisive monetary policy actions. Traders are closely watching this and starting a new round of bets, hoping for the economy to achieve a soft landing. This week, enthusiasm in the tech stocks, cryptocurrency, and junk bond markets has surged again, boosting the confidence of fund managers as they anticipate policymakers may rare cut interest rates by half a percentage point. Following a significant drop in the Nasdaq 100 index the previous week, it has risen nearly 6% for five consecutive days this week, indicating a reversal in market trends. This is the latest twist in the recent market narrative. After being on the verge of succumbing to expectations of an economic recession, stock traders are starting to believe in sustainable growth, especially with expectations of forthcoming loose monetary policies. Some optimistic investors even see an ideal investment environment: an active Federal Reserve that may inject vitality into the still expanding economy through substantial rate cuts. Priya Misra, portfolio manager at J.P. Morgan Asset Management, said, "For the stock market, the best situation is when the economic conditions are good, while rates are low. A rate cut of 50 basis points is good news, as it indicates that the Fed does not want to lag behind." On Friday, futures markets once again showed bets on a sharp cut in benchmark rates, a shift from just a few days ago when such a rate cut seemed unlikely. This shift has driven a strong rise in stocks that are seen as beneficiaries, including value stocks, small companies, and high dividend companies, while the dollar's exchange rate has fallen. Prior to the Federal Reserve meeting on September 17-18, the debate over the magnitude of the first rate cut had intensified. Pricing in the futures market showed a 43% probability of a 50 basis point rate cut, up from 25% a few days ago, but down from nearly 60% a week earlier. Currently, the interest rate futures market anticipates a 100 basis point rate cut by the end of this year, with a further cut of 150 basis points expected in 2025. Economic forecasts for September should suggest more easing policies compared to June, mainly in response to deteriorating labor market conditions. In June, officials' median forecast indicated an unemployment rate of 4% by the end of this year. By July, the unemployment rate had reached 4.3%, slightly dropping to 4.2% in August. The S&P 500 index rose by 4% in five trading days, marking its best weekly performance since November, and is now less than 50 points away from its historical high set in July. The junk bond market also saw an increase, with a major exchange-traded fund ending a two-week decline. However, this week saw gold prices hit a record high, while the 10-year U.S. Treasury yield reached a 15-month low, both indicating signals of economic deterioration. Despite consumer price data being better than expected and the labor market relatively healthy, this suggests that future monetary policy should proceed with caution. Former New York Fed President William Dudley and economist Michael Feroli of J.P. Morgan believe that the Fed should further cut interest rates to avoid falling behind the situation. Feroli wrote in a report on Friday, "We believe it is now clear what the Fed should do next week: a 50 basis point rate cut to adjust to the shifting risk balance." Raphael Tu-An, director of capital market strategies at Tikehau Capital, said the Fed is walking a delicate line. "A 50 basis point rate cut by the Fed in response to economic weakness might disrupt the market, potentially causing volatility by the end of the year," he said. "On the other hand, if the 50 basis point cut is in response to favorable inflation data and central bank officials also provide comforting communication, it may boost risk assets." Regardless of how policymakers act, Doug Ramsey, chief investment officer of Leuthold Group, expressed doubts about how long the celebration of bullish market preparations could last. He pointed out that the unique features of the current rise in risk assets may mean its lifespan is short, including valuations that have not been reset due to a comprehensive economic downturn. Leuthold's data shows that in the past 12 bull markets, only 4 began outside economic recessions, with an average duration only half as long as other bull markets. He wrote in a report, "Bull markets with no typical recession 'father figure' often have shorter lifespans than those with superior genetics, with the S&P 500 Index rising only a third as much as the latter." "If the current bull market matches the average performance of the previous four most cyclical bull markets, it will last until May 2025, with the S&P 500 Index reaching a peak of 5,852 points - about 8% higher than the closing price on September 6th. Not great." Hedge funds are also cautious, as Morgan Stanley's brokerage team reported that hedge funds have lowered their net equity exposure to the lowest level since the end of last year. EPFR Global data compiled by Bank of America shows that overall, market positioning has become more cautious, with U.S. stock funds experiencing their largest outflow in a single week since April. Skeptics also point out that the speed of interest rate changes reflected by federal funds futures - over two percentage points in the next 12 months - is rarely seen outside economic recessions. James Staubin, chief investment officer at Ocean Park Asset Management, said, "With the S&P index near historic highs and credit spreads narrow, the Fed initiating a rate cutting cycle on a large scale seems possible only when the Fed knows something that others don't." "I think a 50 basis point rate cut could potentially have more downsides than upsides on market sentiment. There is still a lot of room for rate cuts if needed. We just haven't gotten to that point yet."