This article was published on 17th September 2024.

The week that was

After hitting a bump the previous week, both the S&P 500 and Nasdaq Composite saw their largest weekly gains in 2024.

Sentiment improved markedly last week, with the CBOE Volatility Index, or “fear gauge”, dropping by 20% to about 16.5. A VIX level of 16 usually indicates the market expects lower fluctuations in stock prices over the short term.

The rally comes just right before the Federal Reserve’s policy meeting, where a decision on interest rates is set to be announced on Wednesday, September 18 (US time).

To summarise, the week started with traders focusing on the Consumer Price Index (CPI) report on Wednesday, which was the final key data before the Fed’s decision.

The report showed a welcoming trend, with US inflation easing to a three-year low in August as consumer prices rose just 2.5%, down from 2.9% in July.

While this gives the Federal Reserve room to cut interest rates this week, a more modest 25 basis-point cut is expected instead of a bigger 50-basis point cut.

“The data strengthened expectations for a 25-basis point rate cut, with the market now pricing in an 85% chance,” said Erik Boekel at DHF Capital.

Further good news came on Thursday when the Producer Price Index (PPI) for August came in at 2.4%, slightly below the 2.5% forecast and matching July’s figure.

The Fed monitors the PPI closely as it reflects price pressures at the factory level before they reach consumers.

Following this data release, market expectations shifted, increasing the odds of a 50-basis point cut.

According to the CME FedWatch Tool, investors now see a roughly 49% chance of the larger cut, up from just 15% on Thursday.

This shift in expectations contributed to another market rally on Friday, boosting stock market gains for the week.

Wall Street divided

Strictly speaking, a 25 basis point cut isn’t really news. Markets have long expected this, even if they didn’t get the timing exactly right (with many initially predicting the first rate cut as early as March 2024).

But this anticipation has been a major factor driving stock market gains over the past 18 months.

Some strategists believe a 25 basis point cut would actually be more prudent than a 50 basis point cut, because the Fed Reserve, they say, shouldn’t be making a larger cut without clear signs of recession or a financial crisis.

“For everyone who’s asking for a 50 basis point cut, I think they should really reconsider the amount of volatility that would cause in short-term funding markets,” Yardeni Research’s Eric Wallerstein told Yahoo.

“It’s just not something the Fed wants to risk.”

Another reason to not go for 50 is the message it would convey – that the Fed must know something that the rest of us don’t.

However, in the event the Fed decides to go for the bigger cut, small caps could get a “significant rally”, says Eric Johnston at Cantor Fitzgerald.

Either way, rate cuts in general are positive for markets, especially when the Fed is cutting rates without the presence of a recession.

Data shows that historically, when the Fed eased policy without an accompanying recession – such as in 1966, 1984, 1995 and 1998 – markets have performed well after the first rate cut.

Source: Stockhead