Markets are recalibrating as rate cuts feel imminent
Those interest rate cuts are finally coming now, right? Right?!?
It’s a recalibration rally across Wall Street:
Financial markets are behaving like inflation has fallen enough that the Federal Reserve will be able to cut interest rates and bolster the growth outlook in the process.
The catalyst? A soft June inflation report that showed core price pressures rose just 0.1% month-on-month, a better outcome than economists had been expecting.
“The Fed is attentive to the risks of keeping interest rates too restrictive for too long and the better news on inflation over the past couple of months should strengthen their confidence that inflation is moving back toward their objective,” writes Ryan Sweet, chief US economist at Oxford Economics. “The improvement on the inflation front recently is good news for growth in real disposable income, which matters for consumer spending.”
Cyclical segments of the stock market — particularly small caps — are outperforming. The iShares Russell 200 ETF is up more than 2% in early trading, poised for its best showing versus the SPDR S&P 500 ETF this year.
Meanwhile, the US dollar is tumbling. The Dollar Spot Index (DXY) is on track for its biggest decline of this year, with a massive decline in the value of the greenback relative to the Japanese yen. Treasury yields — especially those on shorter-dated debt — are likewise falling, with the 2-year yield down double digits.
And precious metals are ripping, with gold up more than 1.5% in the minutes following the release.
We’ve seen this play before: the price action is aligned with what happened in the final two months of 2023, as the sharp deceleration in inflation allowed the Federal Reserve to signal that its tightening cycle was over and the next move would be a cut rather than a hike.
This time, the moves — if sustained — will be all about enhanced confidence that the easing cycle will begin imminently (in this case, September).
It’s rare, though certainly not unprecedented, for the US central bank to be able to cut rates to recalibrate policy and shore up the outlook, rather than responding to a severe shock that’s already wreaking havoc on the economy. Markets seem to be betting this will be one of those happy endings.
