Stocks Embrace Fed’s Swift ‘Recalibration’; BOE Next Up, Reports Reuters

Market Overview from Mike Dolan

As global markets react to the Federal Reserve’s new stance, Thursday sees a more positive outlook following the typical cautious response seen on the first day. Investors are increasingly embracing the Fed’s decision, viewing it as a protective measure toward achieving the elusive goal of a soft economic landing.

Federal Reserve Chair Jerome Powell characterized Wednesday’s substantial half-point interest rate cut as a "recalibration" rather than an emergency response, suggesting that the Fed is intent on quickly establishing a new "neutral" position without being solely prompted by a faltering economy. Notably, dissent came from Fed governor Michelle Bowman, who believed only a quarter-point cut was necessary.

This balance aligns perfectly with the hopes of stock markets throughout the year. While Wall Street’s initial reaction saw a retreat by the close, futures are bouncing back with gains of 1-2%, reaching record levels ahead of the market opening.

In the bond market, Treasuries appear to have anticipated this move, with two-year yields sitting near their two-year lows at just under 3.6%. The gap between two-year and ten-year yields is widening, reflecting the most positive outlook since mid-2022.

Following the Fed’s actions, the dollar initially fell to a new yearly low but has since stabilized. The dollar-yen exchange rate rose as anticipation builds for the Bank of Japan’s upcoming decision. Meanwhile, the British pound reached its highest level in 30 months, with expectations for the Bank of England to hold off on further rate cuts in today’s meeting.

Powell and his colleagues shifted focus from inflation to the labor market, indicating they foresee an additional 50 basis points of easing by year-end and a further 100 basis points in 2025. By reducing inflation forecasts to near the Fed’s 2% target for next year and raising their unemployment rate prediction slightly to 4.4%, they aim for a return to what they consider the long-term neutral rate. Although the long-term rate has been raised to 2.9%, they still expect to reach it by 2026, which is about 200 basis points lower than the current policy rate of 4.75-5.00%.

Despite signaling an expected 50 basis points cut over the remaining meetings of the year, futures markets now price in over 70 basis points and nearly 200 basis points of cuts by this time next year. Bank of America anticipates 75 basis points of cuts by year-end, suggesting that the Fed may be compelled to make deeper cuts should the labor market weaken.

The upcoming weekly jobless claims report will serve as an initial gauge of job market health. Conversely, the Fed’s rate cut underscores a potential rebound in the housing market, supporting ongoing economic expansion, estimated at around 3% for the current quarter. With 30-year fixed mortgage rates now at two-year lows of 6.15%, housing starts saw a significant increase of over 15% last month.

Historically, when the Fed begins cutting rates during an economic expansion, stock markets tend to rise significantly over the next year, particularly among both large-cap and small-cap growth stocks. Ahead of Thursday’s open, futures for small-cap indices are up nearly 3%.

As U.S. futures surge, global markets are also experiencing a rally. In Asia, Tokyo and Hong Kong indices both gained 2%, aided in Tokyo by the yen’s decline and in Hong Kong by a similar rate cut from the territory’s monetary authority. Chinese stocks increased as expectations grow that the Fed’s decision will provide leeway for Beijing to ease monetary policy soon.

In Europe, stocks were also up by 1%. However, the Fed’s easing strategy was less influential in other parts of the world. The Bank of England is expected to postpone a second UK rate cut until November but will give updates on its ongoing balance sheet reduction efforts. If it aligns with past trends, the BoE could see a substantial run-off of £100 billion over the next year, which may reduce active bond sales amidst maturing debt.

Norway maintained its rate at 4.5%, whereas Brazil opted to raise its rates for the first time in two years.

Key developments to watch for in U.S. markets later today include:

• The Bank of England’s policy decision, meeting minutes, and annual balance sheet target, as well as decisions from the Reserve Bank of South Africa and the Central Bank of Turkey.
• U.S. weekly jobless claims, the September Philadelphia Fed business survey, August existing home sales, and second-quarter current account data.
• A speech by European Central Bank board member Isabel Schnabel.
• The sale of U.S. Treasury 10-year inflation-protected securities alongside corporate earnings reports from FedEx, Lennar, Darden Restaurants, and FactSet.