Introduction to the Federal Reserve’s Rate Cut
The moment investors have been waiting for all year is here. Markets have been clamoring for the Federal Reserve to resume its rate-cutting cycle, and the central bank is expected to finally trim its target rate during its announcement. The odds for a cut have risen steadily in the last few weeks thanks to tame inflation data and recent signs of weakness in the job market.
Expected Outcome
On Monday, as the meeting kicked off, the market priced in a 96.2% chance the Fed would trim its target rate by a quarter of a percentage point at the September meeting. JPMorgan also thinks a Fed rate cut is overwhelmingly likely, with a 95% chance the Fed will cut rates in some capacity, and a 87.5% chance it’ll be a 25 basis-point cut.
Market Reaction
Markets are expecting it to be a potentially volatile day for trading. S&P 500 options are pricing in an 88 basis point move on the day of the rate decision. According to Andrew Tyler, the global head of market intelligence at JPMorgan, "We see a Dovish Cut as the most likely outcome, producing a positive gain on the day."
Possible Scenarios
JPMorgan has mapped out several possible scenarios that could unfold this week.
The Fed Cuts Rates by 25 Basis Points and Remains Dovish
The bank sees this as the most likely outcome of the meeting, pegging a 47.5% probability that the central bank will issue a quarter-point cut and issue dovish commentary around the state of the economy. In this scenario, the S&P 500 could gain around 1% immediately after the rate cut, which would imply the benchmark index rising to around 6,650. However, this could eventually lead to more downside for stocks.
The Fed Cuts Rates by 25 Basis Points, but Issues Hawkish Commentary
The next most likely scenario is that the Fed will trim its target rate by the expected 25 basis points but give hawkish commentary about the state of the US economy. That could end up having a negative impact on stocks, with the S&P 500 potentially remaining flat or dropping half a percentage point.
Fringe Scenarios
JPMorgan also mapped out a few less likely scenarios that could unfold this week.
- The Fed holds interest rates steady, which could cause the S&P 500 to fall 1%-2%.
- The Fed issues a jumbo-sized rate cut, which could cause the S&P 500 to swing either way, potentially losing or gaining 1.5%.
Stocks to Buy
If there is a sell-the-news reaction in stocks, JPMorgan suggests considering buying:
- Tech stocks, especially mega-cap tech and AI-themed companies
- Utility stocks, which could see upside as rate expectations and the 10-year US Treasury yield fall
- Healthcare stocks, given strong earnings per share growth and low positioning in the sector
- Biotech stocks, given anticipated M&A activity in the space
Conclusion
In conclusion, the Federal Reserve’s rate cut is expected to have a significant impact on the market. While the most likely outcome is a dovish cut, there are other possible scenarios that could unfold. Investors should be prepared for a potentially volatile day of trading and consider buying certain stocks if there is a sell-the-news reaction. Ultimately, the Fed’s decision will depend on various factors, including inflation data and the state of the job market.
