Market Celebrates a Dovish Fed, but Danger Is Lurking
The historical response to the start of rate-cutting cycles should not be ignored.
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Fed Chair Jerome Powell delivered what the market wanted on Friday. He indicated that inflation is now sufficiently under control and that the Fed feels confident it can begin a rate-cut cycle. The size and speed of the rate cuts are still to be determined, but there is almost 100% certainty that there will be at least a quarter-point cut at the next Fed meeting on September 18.
There are two big events prior to that meeting that may impact what the Fed does, however. The first is Nvidia NVDA earnings, which are due on Wednesday after the market closes. The second is the August Jobs Report, which is out on September 6 prior to the market open.
There is other economic news, such as PCE and Consumer Confidence, that will also have some impact on market sentiment. The data will affect whether there is a half-point or quarter-point hike. Any economic news that shows greater economic slowing will tip the Fed to a half-point hike.
Technically, the market had an extremely strong response to Powell on Friday. Most notably, there was strong rotational action in the Russell 2000 IWM, while the Nasdaq 100 QQQ and the Magnificent Seven (MAGS) had lagging relative strength. Smaller stocks tend to benefit more from rate cuts because they tend to carry more debt and often have greater capital requirements than mega-cap stocks that are usually awash in cash.
While the market saw very good momentum on Friday, there are two obstacles. First, technical conditions are still overbought. There has been no consolidation or significant pullbacks since the low that was hit on August 5. There is overhead resistance lurking as well.
The second issue is seasonality. September — especially later in the month — is historically the weakest month of the year. This is going to occur at the same time that the Fed starts to cut rates. The market has a history of selling off when the Fed actually starts to cut rates.
When the central bank started a rate cut cycle on January 3, 2001, the S&P 500 fell about 39% over the next 450 days, and unemployment rose 2.1%. When the Fed started a rate-cut cycle on September 18, 2007, the S&P 500 dropped 54% over the next 375 days, and unemployment jumped an additional 5.3%.
Conditions are never the same, but a potential sell-the-news reaction to the start of the Fed cutting rates should not be ignored.
We have a mild start on Monday morning.
At the time of publication, Rev Shark was long NVDA.
