What Happened Last Week
- Fed: Equities rallied as the Fed cut 50 bps to kick off its rate-cutting cycle, guiding for further rate decreases down to around 3%.
- Price Action: Risk-on, pro-cyclical trading on the back of Fed cut; small-caps outperformed, credit spreads tightened, and commodities rallied.
- Treasury Yields: Yields rose, and the curve steepened in another potential pro-growth market reaction to the Fed’s moves.
What We’re Watching This Week
- U.S. Data: The Fed’s preferred inflation measure, core personal consumption expenditures, will be released on Friday.
- Bond Auctions: Treasury auctions this week will draw more attention than usual, given the move in yields.
- Japan: A key inflation report and the race to replace the current Prime Minister are important barometers for the future policy backdrop in Japan.
Investment Management Team’s Views
- The market got what it wanted from the Fed last week – a half-point rate cut to kick off their easing cycle and promises of more to come – see our special report on the Fed. While the S&P 500 making fresh all-time highs gets all the press, the bigger takeaway for us was the more risk-on price action across various markets. Oil and other commodities rallied, credit spreads tightened, the yield curve steepened, market-implied inflation expectations climbed, and small-caps outperformed. Meanwhile, the shine came off defensive sectors of the market, like staples and healthcare, as investors recalibrated their recession odds lower in light of the Fed’s bold opening salvo.
- At first glance, the one puzzling thing about last week was the move in bond yields: the 2-year Treasury yield rose 1 basis point, and the 10-year gained 9 bps. But here, we want to underline the context. Since the slight downside miss to payrolls in early August, the market has traded with about 10 total 25 bp cuts priced through the end of next year. That has felt recessionary (and doubtful) to us, and true to form, interest rates have trended downward while defensive equities have outperformed over this time. We think last week’s pro-growth price action may mark the beginning of a reversal in such trends, at least until the next update on the labor market in the first week of October.
- This week will be dominated by the fallout from the Fed meeting. The Fed’s preferred inflation gauge, released on Friday, will be even more scrutinized in light of comments from influential Fed Governor Waller last Friday around the potential for a downside miss to their inflation target. A slew of Fed speakers will also add context to the likely rate path. Outside of monetary policy, three Treasury auctions this week are a good test of the market’s willingness to buy coupons at these low yields. We are also watching policy catalysts out of Japan and China for clues on where this important economic region is headed from here.
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