To The Moon

The Fed's significant rate cut boosted confidence that the central bank will keep the U.S. economy expanding.

On Thursday, U.S. stocks rose sharply, with the $DJIA(.DJI)$ jumping over 500 points and the $S&P 500(.SPX)$ closing above 5,700 for the first time, both setting historical records. This marked the Fed's first rate cut in four years, leading the market to believe it can help the economy avoid a recession.

Prevent Recession, Stocks Exploding

Adam Crisafulli, founder of Vital Knowledge, remarked, “As the market digests this major Fed cut, stocks are exploding. I foresee a strong market leading up to the presidential election.”

This larger-than-expected cut surprised many investors. Jeremy Siegel, a professor emeritus at the Wharton School, stated, “This is the best news I’ve heard from the Fed in years. It’s fantastic for the markets and a great sign for the economy.”

The market believes this rate cut will help prevent a recession. A recent survey found that 75% of respondents expect the U.S. to avoid a technical recession by the end of next year.

Jon Bell, a portfolio manager at Newton Investment Management, observed, “The market is convinced the Fed has it under control, believing they will achieve a soft landing for the economy, leading to a strong rise in risk assets.”

Barclays strategist Joseph Abate suggested that the Fed can reduce rates while also trimming its balance sheet, but advised to end balance sheet reduction early for risk management reasons. He still anticipates the Fed will conclude quantitative tightening by December, with an announcement expected from the FOMC in November.

Abate pointed out, “In 2019, a scarcity of reserves intensified tensions in the repo market, leading to soaring financing rates and significant disruptions in the U.S. Treasury market. We believe the risks of maintaining reserves just above necessary levels outweigh those concerns.”

Will Fed Continue to Cut Rates?

U.S. interest rate futures are betting that the Fed will continue to cut rates at its upcoming monetary policy meeting on November 6-7, with a 64% chance of a 25 basis point cut and a 36% chance of a 50 basis point cut.

Expectations for rates by the end of next year remain largely unchanged, with traders anticipating about 190 basis points of cuts by the end of 2025. This aligns with the previous expectation of 240 basis points before the Fed's recent cut. By the end of 2025, the benchmark rate is expected to reach 2.9%, lower than the Fed's latest forecast of 3.4%.

Small and Mid-caps may Outperform

Some Wall Street strategists believe that amid the Fed's rate-cutting cycle, small and mid-cap stocks may outperform tech stocks and other large caps. The rationale is that small and mid-caps are often very sensitive to the Fed's benchmark rate and heavily reliant on floating-rate loans. A Fed rate cut would significantly ease their debt pressure, potentially boosting profitability and stock valuations.

With the interest rate futures market pricing in nearly a 100% chance of a 100 basis point cut before year-end, a classic rotation into small and mid-cap stocks could occur. This trend may favor stocks that benefit from the rate-cutting cycle and are currently undervalued compared to tech giants at historical highs.

Following the Fed's significant 50 basis point cut, claims for unemployment benefits have plummeted to a four-month low. Zerohedge suggests this indicates the economy is not experiencing a "soft landing."

Analysts note that the decline in unemployment claims to the lowest level since May suggests a healthy labor market despite a slowdown in hiring.