US Stock Market: Direction Hinges Upon Whether Investors Keep 50bps Rate Cut Hopes Alive

James Hyerczyk

The U.S. stock market finished lower last week on relatively low volume and volatility. Perhaps it was the pre-conceived negative earnings expectations due to reports released before the results season started that fueled the lame price action. Perhaps it was options expiration. Uncertainty over the size of the widely expected Fed rate cut at the end of the month may have also been responsible for the lackluster price action and weak performance. Or should we say the lack of clarity from the Fed, which investors seem to think the Fed owes them.

In the cash market last week, the benchmark S&P 500 Index settled at 2976.61, down 1.2%. For the year, the index is up 18.7%. The blue chip Dow Jones Industrial Average closed at 27154.20, down 0.7%. It’s up 16.4% in 2019. The technology-based NASDAQ Composite finished at 8146.49, down 1.2%. This year, it’s gained 22.8%.

Where We Stand So Far

Entering the earnings season, analysts expected S&P 500 earnings to have fallen by around 3%, according to FactSet data. At the end of the week, more than 15% of the S&P 500 companies had reported. Of the companies, 79% have posted a better-than-expected profit, according to FactSet data.

As Jeff Zipper, managing director of investments at U.S. Bank Private Wealth Management put it, “So far, there have been no surprises. Most of the times when the bar is set so low, the results are likely to be in line or slightly better.”

Options Expiration Weighs on Volume and Volatility

Let’s face it, the stock market was pretty dull last week until late Thursday before dovish comments from a prominent Fed official helped the major indexes recover close to half of their losses from four days of selling pressure. The expiration of options on Friday likely amplified the market reaction to his comments. Earlier in the week, however, stocks just drifted lower with investors showing little to mixed reactions to stronger-than expected U.S. economic data and better-than-expected earnings results.

Confusion Over Fed Rate Cut Predictions

Just what are Fed officials expected to say nearly two-weeks before their next two day meeting on July 30-31? “Hey, let’s skip the meeting and cut rates now because that’s what Treasury investors and President Trump want”.  The markets have already priced in a 25-basis point rate cut, and investors are trying to determine whether the cut will actually be an aggressive half-percentage point cut.

On July 16, Fed Chairman Jerome Powell solidified the chances of a less-aggressive Fed cut, but traders already knew that. On July 18, New York Fed President John Williams gave a speech, which many took as a sign the Fed will cut rates more aggressively later this month, but then a spokesperson clarified that Williams’ view is based on “research” and is “not about potential policy actions at the upcoming Federal Open Market Committee meeting.” The news helped produce whip-saw price action in the stock market.

This Week

Stocks could continue to drift sideways to lower this week with the price action driven by low volume as many of the major players begin moving to the sidelines ahead of the European Central Bank policy meeting on July 25 and the Fed’s interest rate announcement a few days later.

Expectations of a 50-basis point rate cut by the Fed will probably drop below 20% at the start of the week. This is based on a Wall Street Journal report released on Friday that said the Fed will cut rates by 25-basis point and cut rates later in the year as needed.

If there is volatility, then it will likely remain centered around whether the Fed cuts 25 or 50-basis points. Some investors continue to say that the Fed must take the aggressive route because policymakers have to convince Wall Street that they are truly serious about providing the firepower needed to continue the current 10-year economic expansion.

This article was originally posted on FX Empire

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