(Bloomberg) — Wall Street traders revived prospects for a half-point Federal Reserve rate cut next week, spurring a rotation into stocks that would benefit the most from policy easing.
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Economically sensitive shares outperformed the group of tech megacaps that have led the bull-market rally, with the Russell 2000 index of smaller firms climbing 2.2%. An equal-weighted version of the S&P 500 — where the likes of Nvidia Corp. carry the same heft as Dollar Tree Inc. — beat the US equity benchmark. That gauge is less sensitive to gains from the biggest companies — providing a glimpse of hope the rally will broaden out.
As the S&P 500 marched from one record to the next in the first half of the year, some investors grew concerned that only a handful of members outside of technology giants were participating in the rally. Corners of the market outside of big tech are barreling higher as investors grow more confident that the start of the Fed cutting cycle will keep fueling Corporate America.
“The biggest news in the last 24 hours has been the shift in odds for a 50 basis-point cut at next week’s Fed meeting,” said Jonathan Krinsky at BTIG. “Small-caps offer better risk/reward in the near-term, and think mega-cap tech likely sees another breather, although it will certainly participate if the S&P 500 makes new highs.”
The S&P 500 rose 0.6%, while its equal-weighted version gained 1%. The Nasdaq 100 added 0.4%. The Dow Jones Industrial Average advanced 0.8%. Treasury two-year yields dropped four basis points to 3.6%. The dollar fell. Gold hit another all-time high.
Eric Johnston at Cantor Fitzgerald says that going into the Fed decision, there’s a “very good” set-up for small caps. That’s the group considered to have the most-positive leverage to a policy easing cycle, he noted, citing the fact that the Russell 2000 has largely underperformed the S&P 500 in the past few weeks.
“The consensus is that the Fed will cut 25 bps, but there is of course a chance that they end up cutting 50 bps,” Johnston said. Small caps “would get a significant rally if it was 50 and still rally with a very dovish 25,” he noted.
Stock markets are likely to trade sideways until US employment data show clear signs of either weakening or strengthening, according to Bank of America Corp. strategists.
The team led by Michael Hartnett said there’s several market factors at play to support both bullish and bearish narratives. While the optimists say technology and semiconductor stocks — including this year’s leader Nvidia Corp. — have bounced off key technical levels, the pessimists warn that “nothing good happens” when bond yields and banking stocks decline at the same time.
Data Friday showed US consumer sentiment rose to a four-month high as short-term inflation expectations fell to the lowest level since the end of 2020.
A steeper pace of cuts aligns with increasing worries about a more pronounced slowdown in the labor market. While the latest inflation prints showed a slight uptick in August, the core personal consumption expenditures index — which is the inflation metric the Fed watches — is expected to be softer.
Countdown to Fed Meeting:
Yes, it is an uphill climb, but I think the Federal Reserve will cut its policy rate by 50 basis points at its upcoming meeting. The case for doing more upfront is strong.
A popular reason to not go 50 is the message it would send. “The Fed must know something the rest of us don’t” or so the thinking goes. I don’t buy this for a second.
There are risks to the market if the Fed only goes 25, especially given the unlikely threshold of a “dovish cut” being met. So, a “how-the-market-would-respond” argument does not feel compelling. My own sense is that markets would welcome the move.
Just when we put the 50 basis-point cut next week on the back burner, the talk of 50 has risen from the dead.
While we originally called for a 50 basis-point cut — and think a 50 cut is the right call — we just can’t see this Fed who is so entrenched in backward-looking numbers, getting to 50. Jerome Powell’s consensus view is that he will not have enough votes to get 50. Hence his strategy will be to go 25 and then be uber dovish, at the presser. That is what we think, rather than we want.
Judging by price action, investors are certainly looking for a dovish rate decision. This could be in the form of a surprise 50 basis-point cut — or 25 basis-point cut, with a strong hint of at least one 50 basis-point reduction in the remaining two meetings later this year.
It is all about the economic growth now and jobs market. You would think that after the hotter inflation data that the implied probability of a 50 basis-point cut would have dropped to zero. In fact, it did fall close to zero, but it has since bounced back and we are back to square one. This implies that there is an equally split chances of a 25 basis-point or 50 basis-point cut next week.
And this is the issue: Now that market is back pricing as much likelihood on the 50 as 25 basis-point cut out of the gates, then anything but 50 will disappointment market pricing.
We maintain that a quarter-point initial cut is the path of least resistance, although it is clear that 50 basis points is on the table and will be part of the Fed’s conversation. We’re cognizant that CPI and PPI are likely to translate into a more benign move in core-PCE. As the Fed’s favored measure, the overall inflation profile will appear less concerning for policymakers and thereby allow the FOMC to focus on the labor market.
The decision to cut between 25 vs 50 basis points could be closer than most people anticipate. In our view, the dot plot will be the most prominent part of the Fed’s guidance next week, along with Chair Jerome Powell’s post-meeting press conference. Our expectation for the Fed’s forward guidance is for it to lean broadly dovish.
Treasuries will focus on the size of the cut, the dot plot, and Powell’s remarks as key guideposts. Given our expectation for the Fed to send a generally dovish tone while delivering a 25bp rate cut to start the cycle, rates can continue to rally and the curve can continue to bull steepen. We favor buying dips in duration.
Corporate Highlights:
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Adobe Inc. delivered an outlook that failed to quell investor impatience for new artificial intelligence tools to start generating cash.
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Oracle Corp. said annual revenue will rise to at least $104 billion in fiscal 2029, an optimistic signal on the growth prospects of the software maker’s cloud infrastructure business. The company’s shares jumped to reach record highs.
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Boeing Co. factory workers walked off the job for the first time in 16 years, halting manufacturing across the planemaker’s Seattle hub after members of its largest union voted overwhelmingly to reject a contract offer and go on strike.
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Energy company Halliburton Co. was downgraded by RBC Capital Markets downgraded to sector perform from outperform.
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Furniture retailer RH reported second-quarter revenue and profit that topped Wall Street expectations. The company touted an improvement in customer demand in recent months, though it cut its sales forecast for the year, saying revenue will lag demand as it adjusts its assortment.
Some of the main moves in markets:
Stocks
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The S&P 500 rose 0.6% as of 10:51 a.m. New York time
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The Nasdaq 100 rose 0.4%
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The Dow Jones Industrial Average rose 0.8%
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The Stoxx Europe 600 rose 0.9%
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The MSCI World Index rose 0.7%
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Bloomberg Magnificent 7 Total Return Index rose 0.4%
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The Russell 2000 Index rose 2.2%
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S&P 500 Equal Weighted Index rose 1%
Currencies
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The Bloomberg Dollar Spot Index fell 0.4%
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The euro rose 0.1% to $1.1089
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The British pound rose 0.2% to $1.3153
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The Japanese yen rose 0.8% to 140.69 per dollar
Cryptocurrencies
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Bitcoin rose 0.3% to $58,346.76
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Ether rose 0.5% to $2,363.69
Bonds
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The yield on 10-year Treasuries was little changed at 3.67%
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Germany’s 10-year yield was little changed at 2.16%
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Britain’s 10-year yield was little changed at 3.77%
Commodities
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West Texas Intermediate crude rose 1.6% to $70.07 a barrel
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Spot gold rose 0.8% to $2,578.23 an ounce
This story was produced with the assistance of Bloomberg Automation.
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